A response to Professor Melody's review of The Telecoms Trade War

Citation

Spiwak, L.J. (2002), "A response to Professor Melody's review of The Telecoms Trade War", info, Vol. 4 No. 1. https://doi.org/10.1108/info.2002.27204aaf.001

A response to Professor Melody's review of The Telecoms Trade War

Lawrence J. Spiwak

I am very honoured that Professor Melody has given our book, The Telecoms Trade War, an overall positive review (Melody, 2001). While I do not want to engage in a review of the review, in the interest of socratic discourse, I would like to respond to Professor Melody's major critique (comprising of one half of his rather lengthy review) of the book – i.e. that we were wrong to cite the FCC's competitive carrier paradigm as a success (which, ironically, is the one of the few FCC policy paradigms we praise).

1. Living in the past: issues of joint profit maximization

Professor Melody's central argument is that the re-classification of AT&T as a non-dominant carrier for domestic long distance service seven years ago was "premature and served the interests of dominant industry players, not competition or consumers." As a result, argues Professor Melody, joint profit maximization is now running rampant in the US long-distance industry, as evidenced by basic rates increasing in "lock step oligopoly fashion." While this response is the inappropriate forum to conduct yet another structure-conduct-performance analysis of the US domestic long-distance market, such polemic statements reveal that Professor Melody has not only failed to keep up with the economic literature and FCC orders on the subject, but also that his facts about the industry are dated circa 1975[1].

For example, there are now over seven national networks serving over 500 IXCs in the USA – hardly the characteristics of a concentrated oligopoly market.

Second, Professor Melody's exclusive focus on "basic rates" – which relatively very few people use (less than 5’per’cent of total revenues by some accounts) and are now completely detariffed[2] – as an exclusive measure of market performance does not tell the complete story (Duvall et al., 1996). As evidenced by the fact that there are a plethora of discount plans available and switching costs (aside from de minimis search costs) are virtually non-existent, you cannot lump the entire pricing structure of the industry into a single basket or category; instead, it appears that there is a tremendous amount of aggressive price competition at the margin occurring in the market[3]. Indeed, rather than see evidence of joint profit maximization, the average US domestic long-distance rate (on a plan) has fallen to 7 cents a minute (if not lower) since the AT&T domestic non-dominant order in 1995[1]. Moreover, vigorous non-price competition (e.g. frequent flyer miles, credit cards, etc.) continues as well, and acquisition costs remain a significant factor to a firm's operating expenses (see, e.g. Galbi (1999)). In fact, competition has become so fierce in the US long-distance industry that the FCC's Enforcement Bureau is busier than ever in trying to resolve slamming and cramming cases[4] – again, hardly evidence of joint-profit maximization.

Similarly, Professor Melody's statement that US long distance companies are not passing through cost reductions is also false. For example, Ford (2001), after empirically evaluating the flow through of settlement costs to international long distance prices, found strong evidence that IMTS prices are closely related to settlement costs, and that these prices fully reflect differences in settlement costs. Moreover, Ford further found that the estimated relationship between prices and settlement cost indicates, under certain assumptions, that the US IMTS industry is very competitive (Ford, 2000). Hill and Beard (1999) show with an innovative statistical analysis that rate reductions in the long-distance industry more than account for access charge reductions. Perhaps most problematic with Dr Melody's focus on flow through is that direct flow through of cost reductions is not necessarily expected in multi-product, competitive markets (Beard and Ford, 2002). Dr Melody's critique falters on both theory and evidence, therefore.

2. Ignoring the "big" story

Notwithstanding the above, by erroneously believing that we are still living under 1975 market conditions and complaining about the FCC's now seven-year-old decision to reclassify AT&T as a non-dominant carrier, Professor Melody ignores the real story about recent telecoms restructuring efforts which we went to great pains to cover in the book – i.e. that since the passage of the US Telecoms Act of 1996 and the WTO Accord on basic telecoms services in 1997 (two events that occurred after the FCC decided to reclassify AT&T as a non-dominant carrier), not only have regulators failed to reduce entry barriers for the "last mile", but that market structure, post-WTO (particularly in US local markets), is probably less conducive to competitive rivalry than pre-WTO and the 1996 Act.

For example: by arguing that there is joint profit maximization occurring in the US long-distance industry, Professor Melody in fact supports the RBOC's primary section 271 argument that their immediate entry into in-region long distance is essential to prevent further harm to consumer welfare, regardless of the "openness" of their own local markets[5]. Given Professor Melody's distinguished record of fighting monopolists, I cannot believe that Professor Melody would condone such a result.

Yet, in Professor Melody's efforts to re-live the past, he totally ignores our lengthy discussion in chapter 9 about the premature re-vertical integration of the US local and long-distance markets. Specifically, that the FCC's policy to permit the RBOCs to retain control over bottleneck facilities as they enter the long-distance market (or at least find that supply is sufficiently elastic so as to prevent the RBOC's incentive and ability to sabotage competitors) runs completely inapposite to competitive carriers. (For example, Verizon, is now the fourth largest IXC in the entire USA, even though the vast majority of its customers come from only three states[6].) To the extent that basic rates have increased, therefore, it is more likely due to this premature re-vertical integration of the market (remember, because the economics and local are so vastly different, the whole idea behind the original AT&T divestiture was deintegration to prevent AT&T, and then the RBOCs, from improperly leveraging market power from the local market into the long-distance carrier market) than any joint profit maximization. In fact, Paul MacAvoy, the champion of the flow-through question discussed earlier, provides analysis that suggests that as concentration in the long-distance industry declines, prices increase (MacAvoy, 1996). The entry of the Bell Companies into long distance has reduced industry concentration, and by some accounts has, as predicted, increased prices.

Similarly, Professor Melody completely ignores our detailed discussion in chapter 9 about the massive reconcentration of the US ILEC industry. As we point out in the book, having one firm with one-third of all access lines in the USA (Verizon) and another firm controlling one-third (SBC/Ameritech) does not promote competition. Instead, these huge economies of scope provide fertile ground for regulatory evasion by allowing the RBOCs to pass through defence costs via forum shopping among multiple state public utility commissions. If Professor Melody is looking for collusion, then he needs to look no further than the ILECs. Rather than compete with each other, the RBOCs have chosen simply to merge – the most effective collusive agreement of all.

Third, Professor Melody ignores the fact that many of CLEC's regulatory charges have actually increased in many instances, thus deterring new entry. For example, as we point out in chapter 15, universal service fees increased significantly post-1996 act. As taxes on gross revenues, these fees without question weaken the case for profitable entry. Moreover, as we point put in chapter 9, although the FCC has ostensibly reduced access charges via its "CALLs" proceeding by eliminating the pre-subscribed interexchange carrier charge ("PIC-C") which long-distance carriers had to collect from customers, the FCC turned around and permitted the RBOCs to recover much of this money through an increased subscriber line charge[7]. While the money shifting was, for the most part, revenue neutral, it was not competitively neutral. The CALLs decision simply spread the proverbial "cream" so thinly that most entrants cannot discern it is there. CALLs, to a large degree, is not much more than an insurance policy for the RBOCs against competitive entry.

3. Conclusion

So why does Professor Melody have such passionate and long-standing vitriol towards competitive carrier? Obviously, he does not believe that competition should be an end point in and of itself (the central theme of competitive carrier)[8], but rather that we should have "selective" competition in order to help the government do its job better. As Professor Melody states clearly in his review: "competition will be the most important and potentially effective tool of regulation, but certainly not a substitute for regulation." Such a remarkable statement reveals a gross perversion of policy priorities and economic theory, because competition should never be a "tool of regulation" and state control. Instead, given residual bottleneck issues associated with the network, narrowly tailored regulation – such as the types of price, conduct and structural regulation we highlight in the book – should be a tool to help a competitive market develop and function effectively. As Hayek (1944) noted nearly 60 years ago:

Although competition can bear some admixture of regulation, it cannot be combined with planning to any extent we like without ceasing to operate as an effective guide to production. Nor is "planning" a medicine which, taken in small doses, can produce the effects for which one might hope from its thoroughgoing application. Both competition and central direction become poor and inefficient tools if they are incomplete; they are alternative principles used to solve the same problem, and a mixture of the two means the neither will work and that the result will be worse than if either system had been consistently relied upon. Or, to express it differently, planning and competition can be combined only by planning for competition but not by planning against competition.

Accordingly, I want to reiterate that I am honoured that Professor Melody has broadly endorsed our book. But, while I greatly respect Professor Melody for being one of the first to challenge the old Bell System, the world has dramatically changed since the 1960s and early 1970s when Professor Melody worked at the FCC. As such, his polemic lacks contemporary significance and does little to contribute to the current dialectic.

Notes

1. 1.

   See, e.g. Clamp-All Corp v. Cast Iron Soil Pipe Institute, 851 F.2d 478, 484 (1st Cir. 1988), cert. denied, 488 US 1007 (1989) (Breyer,’J.) (rejecting argument that anti-trust policies warrant the imposition of stringent conditions to remedy interdependent pricing, "not because [interdependent] pricing is desirable (it is not), but because it is close to impossible to devise a judicially enforceable remedy for 'interdependent' pricing. How does one order a firm to set its prices without regard to the likely reactions of its competitors?"); in re Motion of AT&T Corp. to Be Reclassified as a Non-Dominant Carrier, FCC 95-427, 11 FCC Rcd. 3271 (1995) at para 32 ("When the economic costs of regulation exceed the public interest benefits, the Commission should reconsider the validity of continuing to impose such regulation on the market"); see also Kattan (1994), Cornell et’al. (1980) and Haring and Levitz (1989).

2. 2.

   Policy and Rules Concerning the Interstate, Interexchange Marketplace, Implementation of Section 245(g) of the Communications Act of 1934, CC Docket No. 96-61, Second Report and Order, 11 FCC Rcd 20730 (1996) (Second Report and Order); Policy and Rules Concerning the Interstate, Interexchange Marketplace, Implementation of Section 245(g) of the Communications Act of 1934, CC Docket No. 96-61, Order on Reconsideration, 12 FCC 15014 (1997) (Reconsideration Order); Policy and Rules Concerning the Interstate, Interexchange Marketplace, Implementation of Section 254(g) of the Communications Act of 1934, CC Docket No. 96-61, Second Order on Reconsideration and Erratum, 14 FCC Rcd 6004 (1999) (Second Reconsideration Order); Domestic, Interexchange Carrier Detariffing Order Takes Effect, CC Docket No. 96-61, Public Notice, DA 00-1028 (Com.Car.Bur. May 9, 2000) (May 9 Notice).

3. 3.

   See generally Evans and Schmalensee (1966). The authors explain that because many network industries are characterized by high fixed costs and low marginal costs, firms that price at marginal cost "would not recover their fixed costs, which are often the costs of developing innovative new products and services. To survive, they have to price well in excess of marginal cost. And, since they are making a profit at the margin on almost every unit, they often engage in price discrimination such as volume discounts, special deals, and complex pricing systems."

4. 4.

   Report by FCC Enforcement Chief to Federal Communications Commission, 17 January 2002 at p.14 (available at http://www.fcc.gov/eb/reports/progpres.pdf).

5. 5.

   Indeed, if one were to take the RBOC's argument to its logical conclusion, then one RBOC would equal 500 IXCs.

6. 6.

   See Verizon Press Release, Verizon Communications Reports Solid Results For Fourth Quarter, Provides Outlook for 2002, January 31, 2002, where Verizon claims that Verizon Long Distance is now the nation's fourth largest long-distance provider, ending 2001 with 7.4 million customers in 40 states, an increase of 2.7 million during the year, or 59 percent. Moreover, according to Verizon, approximately 40 per cent of the long-distance customer base comes from just three states where the service has been most recently introduced. See also Trends in Telephone Service, IAD, CCB, FCC, August, 2001.

7. 7.

   In the Matter of Access Charge Reform, FCC 00-193, Sixth Report and Order in CC Docket Nos. 96-262 and 94-1, Report and Order in CC Docket no. 99-249 and Eleventh Report and Order in CC Docket No. 96-45 (Rel. May 31, 2000).

8. 8.

   See Adams (1986), (primary purpose of economic public policy paradigms should be to "perpetuate and preserve, in spite of possible cost, a system of governance for a competitive, free enterprise economy" where "power is decentralized; … newcomers with new products and new techniques have a genuine opportunity to introduce themselves and their ideas; … [and] the 'unseen hand' of competition instead of the heavy hand of the state performs the basic regulatory function on behalf of society").

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