Last Thursday, the FCC released its Draft Report & Order ("Draft R&O") in the Business Data Services ("BDS") (formerly "Special Access") proceeding. At first glance, the Commission's Draft R&O does a lot of things right; not least of which is finding the needle of rational, targeted rules in a gigantic 15 year old haystack of a public record.
As we've explained previously, then-Commissioner Pai's characterization of the previous Commission's "analysis" in its Tariff Investigations Order/FNPRM in this proceeding as "a trip through the looking-glass" was not wrong. In the Lewis Carroll story, Alice escapes from the looking-glass world by imposing rationality (she grabs and shakes the Red Queen--who she blames for all the chaos of the day--which then places the Red King in "checkmate," thus ending her dream by ending the metaphorical "game"). See Wikipedia summary.
Similarly, Chairman Pai returns the FCC's BDS proceeding to reality by seizing control of a chaotic record and wringing some logic out of the multiplicity of data in the Commission's possession (compiled at great cost to both BDS providers and the Commission). Pai, thereby, places the previous Commission's focus on the preferred outcomes of specific parties in "checkmate," and returns the proceeding to reality. But, what does this mean?
Return to Procedural Integrity/Reliance on Public Record
While many are aware of Adam Smith's observation that, "[p]eople of the same trade seldom meet together . . . but the conversation ends in a conspiracy against the public," few are aware of how the paragraph ends:
But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.
Wealth of Nations, Book I, Ch. 10, Para. 82 (emphasis added). Chairman Tom Wheeler's FCC was arrogantly dismissive of both Smith's initial concern--that competitors' collaborations might harm the public--as well as Smith's admonition that the "law" should not promote, much less condone, such assemblies between competitors.
Thus, Wheeler supported adopting a negotiated proposal between two self-interested parties that would have imposed across-the-board, nationwide price regulation on any service below 50Mbps. Worse still, as we noted then, the Wheeler FCC was actively manipulating procedural rules in order to foreclose public comment (that the Commission's own evidence did not support this privately negotiated outcome). By contrast, the current Commission's Draft R&O focuses entirely on the record evidence and getting its analysis correct.
Eliminates Barriers to 5G Backhaul Investment
The FCC, on its 5G page, acknowledges that the many benefits of the projected speed/capacity advances (10X-100X LTE) of 5G are critically dependent on massive fiber investment to provide backhaul to the many more small cell sites that this technology requires. Even former FCC Chairman, Tom Wheeler, acknowledged the necessity of increased fiber backhaul in this June 2016 speech. See p.6.
Wheeler, however, was prepared to disregard the consensus view of economists that governmental price controls generally have the paradoxical effect of reducing both the quality, and availability, of the product/service subject to price controls. See, e.g., experience w/rent control policies. Instead, Wheeler embraced the idea (of interested parties) that the FCC should set price limits on all services below a certain threshold.
This Multichannel News article from 9 months ago, notes that 50Mbps was considered "table stakes" and likely would have ultimately included even higher capacity services. At this time, speculation about a radical change in regulatory policy was rampant, and it is almost certain that some plans for additional fiber investment were put on hold.
We can see further evidence of the chilling effect of previous threats of price regulation in the FCC's tentative decision (in its Draft R&O) to affirmatively classify certain new competitive services (Ethernet over legacy cable facilities) as "private carriage." In doing so, the FCC rejects the previous Commission's desire to classify--as a predicate to expanded price regulation--all BDS services as common carrier telecommunications services. See Draft R&O, paras 253-273. This classification allows these new entrants to participate in the provision of fiber transport/wireless backhaul without being subject to legacy common carrier regulations, like the obligation to serve all customers on similar terms.
Rationally Protecting Consumers
The measure of good economic regulation is that it works to limit market power where competition does not yet exist. In 2002, AT&T (the CLEC) filed its Petition for Rulemaking because, after only two years, the Commission's 1999 Pricing Flexibility Order allowed widespread deregulation (throughout the entire MSA) on the thinnest of theoretical evidence ("collocation" in a small number of ILEC central offices.)
In the Draft R&O, the FCC fixes this problem in two critical ways. First, it reduces the size of the geographic market over which deregulation is granted. On average, the Commission shows that an MSA is about 7X larger than the county-wide market that the FCC proposes.
Second, the FCC demands real-world proof that effective competition exists in the county, before granting deregulation. At least 50% of the locations in the county that use BDS must be within a half mile of a competitive network, or at least 75% of the census blocks in the county must be served by mass-market cable broadband service.
The Commission estimates that, under present market conditions, most of the 3,100 counties in its initial market test computation (about 63%) will be considered "competitive," and deregulated entirely. See Draft R&O, para 146. Customers still in "non-competitive" counties, however, will now be even better protected by regulation, because the FCC re-imposed the dormant-since-2003 "productivity factor," which allows customers to benefit (in the form of lower rates) from expected ILEC cost declines. See Draft R&O, paras 190-248.
All Things Considered . . .
Chairman Pai deserves a lot of credit for coming close to the ideal of intelligent regulation: rules that are applied on a granular basis where needed, and eliminated entirely in those product/geographic markets where competition is sufficient to provide a superior result than regulation. Not everyone will like the FCC's approach, but, it efficiently solves the problem identified by AT&T in 2002--and late is better than never.
Earlier this week, I had a post explaining just how far afield the Tariff Investigations Order portion of the FCC's special access, now "business data services" ("BDS"), Tariff Investigations Order and Further Notice of Proposed Rulemaking ("FNPRM")strayed from rational decision-making. Unfortunately, since Chairman Tom Wheeler has taken the helm of the FCC, irregular departures from reasoned--and, more importantly, fair--decision-making have become the norm for this proceeding.
Yesterday, AT&T posted a statement on its public policy blog once again drawing attention to the lack of procedural due process with which AT&T believes the FCC has conducted its BDS inquiry. AT&T's Senior Vice President--Federal Regulatory, Bob Quinn provided a detailed description of the Commission's latest procedural irregularity: the Commission's introduction into the record of this 228 page filing containing previously-unseen revisions/critiques/analyses of the work of the FCC's 3d party economic expert--on the same day that public comments were due. AT&T concludes that,
the [FCC's] lack of due process only reinforces that this agency is driving to reach a pre-ordained outcome.
See, AT&T Public Policy Blog. AT&T's statement was its second this year (previously here).
AT&T's charges deserve more attention than "ordinary" criticisms of adversely-affected parties, because not only do AT&T's complaints refer to procedural fairness (not whether the FCC agrees with AT&T), and its previous complaint about this issue came 2 months before the company suffered an adverse decision. Finally, AT&T's concerns--that the Commission is driving toward a pre-ordained outcome--seem to be supported by independent events (from those cited by AT&T) taking place in the FNPRM proceeding this week.
The INCOMPAS-Verizon Proposal Advances
As mentioned in a previous post, on April 7th, INCOMPAS (the CLEC trade association) and Verizon started combining their BDS regulatory advocacy. Chairman Wheeler lauded the proposal immediately, as did the most politically influential lobbying/interest group here, and the FCC prominently mentioned the proposal in the first paragraph of its pending FNPRM. See Order/FNPRM at para. 159.
Earlier this week, on June 27th, INCOMPAS and Verizon sent in another joint letter ("INCOMPAS-Verizon June 27th Letter")--elaborating on the parties' previous "compromise" proposal. Chairman Wheeler seems unlikely to share Adam Smith's skepticism that,
[p]eople of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.
Thus, we can expect the Commission to take direction from this second, more specific, appeal for greater regulation.
Despite Contradicting the FCC's Own "Findings"
The INCOMPAS-Verizon proposal clearly has traction with the Chairman's Office, at a minimum. This is in no way more apparent than in the fact that the principle point of the letter would require the Commission to immediately renounce one of the "key findings" in its FNPRM--yet, the parties feel no obligation to address, or explain, this apparent inconsistency with the market realities, as seen by the Commission.
In its FNPRM, the FCC lists as one of its "key geographic market findings" the observation that,
[p]otential competition is important, that is, nearby suppliers can constrain BDS prices. For example, we find that fiber-based competitive supply within at least half a mile generally has a material effect on prices of BDS with bandwidths of 50 Mbps or less, even in the presence of nearby UNE-based and HFC-based competition.
See Order/FNPRM at para 161. In other words, the FCC observes that many areas of the country exhibit competitive characteristics, notwithstanding the number of actual competitors offering service in these census blocks. Instead, the Commission observes, the presence of a potential competitor within a half mile of a building will constrain the prices of every other competitor actually serving the building--even for the smallest capacities of bandwidth (50 Mbps and below).
Compare, however, the "compromise" offered by INCOMPAS and Verizon that,
we agree that all Business Data Services at or below a specified threshold should be deemed non-competitive in all census blocks. We agree that the specified threshold should be no lower than 50 Mbps.
See, INCOMPAS-VZ June 27th Letter at p. 2 (point 2). And, in case you're wondering what a "non-competitive" designation means, the parties "support ex ante price regulation for all Business Data Services deemed non-competitive." Id. (point 6).
Thus, while the FCC makes a "key finding" that prices are constrained--even at the lowest capacity levels--without regulation in many parts of the country (notwithstanding the number of actual competitors selling service in these areas), INCOMPAS and Verizon urge the Commission to adopt a nationwide presumption that the opposite is true. Given the apparent influence of these parties with this Commission (and the undisputed clout of those supporting this compromise), I'd be willing to bet that the Commission ends up believing the advocacy of INCOMPAS and Verizon over "its own lyin' eyes."
It's easy to dismiss the protestations of parties that don't prevail in a Commission matter as "sour grapes." But, it's harder to ignore complaints--before a party has even lost--that they won't get a fair chance to be heard, then the integrity of the system is called into question and we should all be interested. Finally, concerns about the FCC moving toward a pre-ordained outcome are worse still when any casual observer can notice that some parties have a map to that pre-ordained destination--and others, including the public, are just along for the ride.
In his Dissenting Statement from the FCC's recent Business Data Services Order and Further Notice of Proposed Rulemaking ("BDS Order"), FCC Commissioner Ajit Pai compares the FCC's decision to expand its regulation of the "business data services" market to the world Alice encountered in "Through the Looking Glass, and What Alice Found There." In order to give you some idea of what Commissioner Pai was talking about, let's just look at some of the most obvious errors the FCC makes in its wholesale abandonment of rational decision-making.
Business data services ("BDS") are dedicated circuits that transmit data at speeds of 1.5Mbps or 45Mbps between the customer's location and another point on the incumbent LEC ("ILEC") network. After the break-up of AT&T in 1982, the FCC set prices for the competitive "long-distance" inputs (supplied by the ILECs) of switched and "special" access. Almost 35 years later, in its BDS Order, the Commission renames "special access" as BDS, but continues price regulation.
In its BDS Order, the FCC makes a finding that certain provisions in the legacy incumbent telephone company discount tariffs for business data services are "unjust and unreasonable." Notably, the FCC made no finding as to the "just and reasonable" nature of the ILECs' basic "month-to-month" retail rates for BDS.
The Commission found only that certain terms and conditions the ILECs required in order for a customer to qualify for the largest discounts off the retail rate were "unjust and unreasonable." Moreover, the Commission also found that the some of the penalties (for the customer failing to meet purchase volume, or contract term, commitments) allowed the ILECs to recover more from a "breached" contract than the ILEC would have received if the customer had fully performed.
The Threshold Fallacy
From the outset, we can readily see that the FCC has a bit of a logic problem that it needs to explain, before it can resolve the tariff complaints. The "month-to-month" BDS rates have not been challenged as unjust/unreasonable, nor do these rates require a purchaser to agree to buy any specific number of circuits or hold the circuits for any period of time.
Given that any customer can purchase BDS on "just and reasonable" rates, terms, and conditions, then wouldn't any rates below the "month-to-month" BDS rates--regardless of terms and conditions--have to be, by definition, just and reasonable rates? The Commission never explains how it can rationally determine that any terms and conditions--which result in lower prices than the already-established-just-and-reasonable-prices--can be "unjust and unreasonable."
Where's the Law?
When you read the BDS Order, one of the first things you'll notice--as opposed to every other FCC Order--is that the Commission never explains the prevailing legal standard. Of course, the FCC notes that Section 201(b) of the Communications Act requires that,
[a]ll charges . . . for and in connection with such communication service, shall be just and reasonable, and any such charge . . . that is unjust or unreasonable is declared to be unlawful . . .
See 47 U.S.C. Sec. 201, but this tells us nothing about what the "just and reasonable" requirement means.
Moreover, because "just and reasonable" is an unambiguous, statutory term, the Commission will get no deference from the Court of Appeals. So, why wouldn't the Commission at least get the precedent it wants to rely on in its Order?
What the Law Says
In Verizon v. FCC, 535 U.S. 467 (2002), the Supreme Court's review of its Iowa Utilities Board remand to the 8th Circuit, Justice Souter, writing for the majority, offers a historical summary of the evolution of the "just and reasonable" standard with respect to rates between businesses (vs. rates between the utility and the public).
When commercial parties did avail themselves of rate agreements, the principal regulatory responsibility was not to relieve a contracting party of an unreasonable rate . . . but to protect against potential discrimination by favorable contract rates between allied businesses to the detriment of other wholesale customers.
See, Verizon, at p. 479 (internal citations omitted). Justice Souter also notes that, with respect to rates/terms set by contract between two commercial providers, the Court has previously stated that,
the sole concern of the Commission would seem to be whether the rate is so low as to adversely affect the public interest--as where it might impair the financial ability of the public utility to continue its service, cast upon other consumers an excessive burden or be unduly discriminatory.
Id. at pp. 479-480 (citing FPC v. Sierra Pacific Power Co., 350 U. S. 348, 355 (1956)).
Thus, Supreme Court precedent, with respect to "just and reasonable," would limit the Commission's ability to step in and void a contract tariff rate/term between two sophisticated entities to situations where the rate was too low, and reflected an improvident "giveaway" to a commercial customer, at the expense of other customers.
Competition Cannot Be Harmed By Limitations on BDS Discount Availability
In its BDS Order, the FCC states that it has previously expressed concerns about the "potential anticompetitive nature" of the ILECs' term and volume discount plans. Order at para 92.The latest expression of concern the FCC cites is from 1996--when Congress gave the FCC a much more effective tool for determining prices/terms between ILECs and their competitors--the Telecommunications Act of 1996, which allows the FCC to order ILECs to provide access to "unbundled network elements" ("UNEs"), at rates much lower than BDS tariff rates, if the FCC believes that competitors would be impaired in their ability to compete "but for" access to the UNEs.
But, the Commission knows the CLECs/wireless carriers cannot credibly make such a claim. In 2004, the D.C. Circuit pointed out,
[a]s we noted with respect to wireless carriers' UNE demands, competitors cannot generally be said to be impaired by having to purchase special access services from ILECs, rather than leasing the necessary facilities at UNE rates, where robust competition in the relevant markets belies any suggestion that the lack of unbundling makes entry uneconomic.
U.S. Telecom Ass'n. v. FCC, 359 F.3d 554, 591 (D.C. Cir. 2004) (emphasis added) .
The FCC and the ILECs' wholesale BDS customers have known for quite a while that the FCC couldn't credibly require ILECs to give them access to UNEs, because BDS availability has stimulated, not thwarted, competition in related markets. But, the statutory term, "just and reasonable," sort of sounds like an unbounded grant of Goldilocks-level discretion. The FCC, seeing saw no reason to reflect on logic, or precedent, moved ahead with its plans to help another privileged class of competitors. And that is how the FCC went Through the Looking Glass.
One of my favorite episodes of the TV comedy series "Seinfeld" is called "The Opposite," in which George Costanza reflects on his life, and realizes it is the opposite of what he hoped it would be. At the diner, George tells his friends "that every decision I've ever made, in my entire life, has been wrong." His best friend, Jerry, suggests "[i]f every instinct you have is wrong, then the opposite would have to be right." (quotes from IMDB, episode 5.21) By the end of the episode, after consistently "doing the opposite" of what he would normally do, George's life has corrected itself: he is dating a beautiful woman, has his dream job with the New York Yankees, and is able to move out of his parents' house.
Verizon Training Video
The episode starts with the universal human emotion of regret, and then humorously illustrates common logical fallacies, which are presented as both problem ("every decision I've ever made has been wrong") and solution ("the opposite would have to be right"). And, even though both problem and solution are products of fallacious reasoning . . . hijinks ensue--and problems resolve. But, certainly, no one would actually take this seriously--especially not one of the largest companies in the country--would they?
If its Public Policy Blog is reflective of its corporate mindset, Verizon--based on a couple of recent posts--appears to be willing to give George's zany solution a try. But, are they really "doing the opposite," or have they just changed--as competition forces all firms to do?
A Net-Neutrality Flip?
First, on March 21st, Verizon in the context of net neutrality decides to "make clear what Verizon stands for and what kind of policies we support, regardless of the outcome of [the pending Open Internet Order appeal]." And, as it turns out, the rules/policies that Verizon thinks "are fair, even-handed, good for consumers and essential for us and others to thrive going forward" . . . are pretty much the same rules the Commission adopted in its first Open Internet Order in 2010. In other words, Verizon now endorses the very rules that were vacated as the result of the D.C. Circuit's decision in . . . Verizon v. FCC.
Clearly, Verizon was seized with regret over an appeal it now realizes it could have lived with, but traded for worse rules, and is now "doing the opposite," right? At first glance, it would seem to be the case, but, the blog is quick to explain that this is not a simple case of human regret (or any other human emotion) finding its way into Verizon's corporate offices.
Rather, according to Verizon, it is not the same company it was five years ago, when it appealed the FCC's 2010 Open Internet Order. In the intervening time period, Verizon notes, it has "invested billions in businesses that depend on the ability to reach customers over the networks and platforms of others." Indeed, since 2013, Verizon has built its Digital Media, content and ad delivery, business through the acquisitions of EdgeCast, upLynk, Intel's OnCue ad delivery platform, and AOL.
Thus, Verizon's net neutrality position is not really an example of it doing "the opposite" (though, of course, it would have saved itself and everyone else a lot of hassle and expense had it just recognized this before it appealed the 2010 Open Internet Order). But this isn't Verizon's only, or even best, example of "doing the opposite" in the last month alone.
Verizon's Special Access "Compromise"
Last week Verizon decided to "up" the "opposite," and suggested--along with Chip Pickering, head of INCOMPAS (the rival carrier association formerly known as CompTel)--that the FCC should probably go ahead and regulate "new networks" along with the old special access circuits still subject to FCC regulation. Verizon has long fought against any regulation of its data transmission services and has already received FCC forbearance and been selling its packet, Ethernet, and SONET optical services without regulation for almost 10 years, so this is a clear Costanza-esque flip-flop, right?
Let's take a closer look at the letter that Verizon and INCOMPAS jointly sent the FCC. The letter asks the FCC to: 1) immediately, make all dedicated services--regardless of technology--"subject to Title II of the Communications Act, including Sections 201 and 202;" 2) seek comment on a permanent regulatory framework, which would include ex ante price regulation in "relevant markets" where competition is "insufficient."
When looking at whether Verizon is really "doing the opposite," it helps to keep in mind the "not the same Verizon" caveat. In addition to Verizon's recent digital media investments, the company has been divesting itself of its wireline (telephone + ISP + TV) properties for years, and at an accelerating pace in the wake of the FCC's reclassification of Internet access services.Similarly, based on Verizon's pending XO Communications acquisition, and its reported interest in Yahoo!, Verizon may well see INCOMPAS as more of a future trade association, and less of a regulatory opponent, these days.
Until the terms "relevant market" and "insufficient competition" are defined, it's difficult to say how much of Verizon's future revenues are likely to be affected. Given the Chairman's immediate endorsement of the "compromise," it's doubtful that Verizon is worried about having too much of its future revenues tied up by the regulation it's endorsing. On the other hand, if you are a cable company--or a telecom carrier with some unique routes--Verizon's "compromise" seems more like the good, old-fashioned, Washington-style compromise . . . of someone else's opportunities.
* * *
In his more lucid, less politically-driven, first days on the job, Chairman Wheeler noted that every previous "network revolution" changed the world dramatically, and counseled that "we should not, therefore, be surprised when today's network revolution hurls new realities at us with an ever-increasing velocity." When the velocity of new realities forces a rational economic actor to change positions as dramatically as a TV sitcom actor, it's safe to assume that the industry forcing those new realities is not subject to anything but competitive market forces. So, why is it so hard for Chairman Wheeler to accept that the last thing a dynamically evolving "revolution" needs is more 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.
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.
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. Carriers 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.
If 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?!
Well, 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. .
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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?
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.
Bandwidth 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?
No 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).
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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.