|
Before the
FEDERAL COMMUNICATIONS
COMMISSION
Washington, D.C. 20554
| In the Matter of | ) | |
| | ) | |
| Implementation of the Non-Accounting |
) | | | Safeguards of Sections 271 and 272 of the | ) | |
| Communications Act of 1934, as amended | ) | |
| | ) | CC Docket No. 96-149
| | and | ) | |
| | ) | |
| Regulatory Treatment of LEC
Provision | ) | |
| of Interexchange Services Originating in the |
) | | | LEC's Local Exchange Area | ) | |
REPLY COMMENTS OF
THE
UNITED STATES DEPARTMENT OF JUSTICE
David Turetsky
Deputy Assistant Attorney General
Antitrust Division
Communications with respect to this document
should be addressed to:
Donald J. Russell
Chief
Telecommunications Task Force
Michael J. Hirrel
Scott B. Murray Attorneys
Telecommunications Task Force . John Hayes
Economist
Economic Regulatory Section
| Page i
SUMMARY
In
this proceeding the Commission considers measures to implement the
Telecommunications Act's safeguards when BOC affiliates are authorized to provide
in-region,
interLATA, services. Such measures are appropriate and will be helpful. The Commission
should recognize, however, that regulatory measures cannot be as effective in preventing
anticompetitive abuses as competition in local exchange markets.
The
Commission's authority under Sections 271 and 272 of the Act extends to all
interLATA telecommunications, whether interstate or intrastate. Such authority is
expressly
conveyed by the Act, and that conveyance supersedes the earlier jurisdictional principle stated
in
Section 2(b) of the 1934 Act. The Commission's interLATA authority includes
telecommunications from one LATA to points outside the LATA, including international
points.
And where two BOCs merge, their successor "region" includes the two formerly separate
regions.
With
respect to structural separation and antidiscrimination, the Commission appears to
support maximum separation and firm enforcement of the Communications Act's
antidiscrimination measures. This approach is fully appropriate. Similarly appropriate is
the
Commission's emphasis on vigorous enforcement of the safeguards created by Sections 271
and
272 of the Act. The Commission should require the BOCs and their in-region long distance
affiliates to file periodic reports concerning 1) costs arising from each other or from third
party
vendors related to the other, and 2) the quality, quantity and timing of services provided to
each
other. The burden of proof should be shifted in 90-day complaint proceedings to the
defendant
BOCs. And no presumption of reasonableness should attach in complaints concerning
violations
Page ii
of Section 271.
The
Commission should not apply its dominant carrier regulations to BOC affiliates. The
measures we suggest above, combined with continued dominant carrier regulation of BOC
parents and the other measures the Commission proposes, are better tailored to address the
market power arising from the BOC's control of bottleneck facilities. Application of the
dominant carrier regulations to the affiliates may have unintended adverse consequences.
Because the dominant carrier regulations should not be applied to the affiliates, the
Commission
need not engage in precise market definition here.
.
Page iii
TABLE OF CONTENTS
I. Introduction.......................................................................................................................... 1
II. Scope of the Commission's Authority over Intrastate InterLATA
Telecommunications
Services (Paragraphs 20 -
27).............................................................................................
5
III. International Telecommunications Authority (Paragraph
32)............................................ 8
IV. Effect of Mergers on Extent of
BOC Regions (Paragraph 40)...........................................
8
V. Structural Separation and Antidiscrimination (Paragraphs 55
-89).................................. 10
VI. Enforcement of Sections 271
and 272 (Paragraphs 94 - 105)...........................................
12
VII. Regulation of BOC Affiliates
as Dominant or Non-dominant Carriers
(Paragraphs 15 -18, 108 -
162)..........................................................................................
16
A. Raising Prices By Restricting
Output....................................................................
17
1. Market
Definition.......................................................................................
18
B. Harm to
Competition in Downstream Markets by Exercising Market Power in
Upstream
Markets.................................................................................................. 22
1. Market
Definition.......................................................................................
22
2. Exercise of Market
Power.......................................................................... 24
3. Regulation to Address This Market
Power................................................ 26
.
Page 1 .
Before the
FEDERAL COMMUNICATIONS
COMMISSION
Washington, D.C. 20554
.
| In the Matter of | ) | |
| | ) | |
| Implementation of the Non-Accounting |
) | | | Safeguards of Sections 271 and 272 of the | ) | |
| Communications Act of 1934, as amended | ) | |
| | ) | CC Docket No. 96-149
| | and | ) | |
| | ) | |
| Regulatory Treatment of LEC
Provision | ) | |
| of Interexchange Services Originating in the |
) | | | LEC's Local Exchange Area | ) | |
REPLY COMMENTS OF
THE
UNITED STATES DEPARTMENT OF JUSTICE
The
United States Department of Justice ("Department") submits the following Reply
Comments in the above captioned proceeding. In this proceeding, pursuant to Sections 271
and
272 of the Communications Act, the Commission is considering measures designed to
restrict
potential abuses of market power and unfair methods of competition by the Bell Operating
Companies ("BOCs") in the long distance telecommunications market. The Department
offers
these Reply Comments to assist the Commission in its consideration of the competitive
implications of this rulemaking.
I. Introduction
The
Commission's Notice of Proposed Rulemaking chiefly concerns measures designed
to implement Section 272 of the Act, which is intended to protect the public, and to
promote
competition, during the transitional phase that will occur after the BOCs are permitted to
provide
Page 2
in-region interLATA services. The BOCs may of course provide such services only after
they
have met the conditions laid out in Section 271 of the Act.
The
Department urges the Commission to adopt a variety of measures, discussed below,
that would facilitate the detection of some kinds of anticompetitive discrimination and cost
misallocation by the BOCs, and that would enhance the Commission's ability to enforce the
rules
prohibiting such behavior. We believe, however, that the Commission should not require
the
BOCs' interLATA affiliates to comply with the regulatory measures typically associated
with
"dominant carrier" status.
We
do not suggest that these measures could effectively eliminate anticompetitive
behavior in an environment in which the BOCs' historic market power is undiminished.
Regulatory restraints may alter, but they do not eliminate, opportunities for abuse of this
market
power, and they have little impact on incentives to abuse this power. The inherent difficulty
of
regulating anticompetitive abuse when the same firm controls local bottleneck facilities
and
participates in the downstream long distance market was an important reason why the
integrated
Bell Telephone System was broken up in the first place. U.S. v. AT&T, 552 F.Supp.
131, 165-68
(D.D.C. 1982).
Indeed, the limited effectiveness of regulation was recognized by Congress, as
reflected
in the provisions of Section 271. Congress did not regard the regulatory protections specified
in
Section 272, standing alone, as sufficient protection against anticompetitive abuses of
BOC
market power. These regulations constitute only one of several requirements for BOC
provision
of in-region interLATA services. First, Congress required the Commission to implement and
the
BOCs to comply with the "competitive checklist" as a pre-condition to in-region long
distance
Page 3
entry. In so doing, Congress unmistakably declared that local competition was needed, not
only
to bring benefits to consumers of local services, but also to protect competition in and
consumers
of interLATA services.
Second, Section 271(d)(3)(C) also conditions in-region long distance entry on
a showing
by the BOC that such entry is "consistent with the public interest, convenience, and necessity."
Under well-established judicial and Commission precedent
1 this requirement demands that the
Commission consider, among other things, whether entry would promote or harm
competition. 2
This provision would have been unnecessary had Congress concluded that regulatory
measures
alone (including the regulation required by Sections 251 and 272) would constitute
sufficient
protection against anticompetitive conduct.
Third, in weighing applications under Section 271, the Commission is required
to consult
with the Department of Justice and to give "substantial weight" to its recommendations
concerning 271 applications. This requirement reflects a Congressional decision that an
analysis
of competition must be an integral component of the Section 271 process. This requirement,
too,
indicates that Congress regarded regulation by the Commission as a necessary but not
sufficient
Page 4
condition for interLATA entry by the BOCs.
Moreover, while requiring a variety of regulatory measures to promote the
development
of competition in local exchange and access markets, Congress also envisioned the
eventual
deregulation of telecommunications markets. Congress did not intend for
deregulation to permit
the exercise of unchecked market power. Rather, it envisioned markets in which
deregulation
would serve consumer interests because market power had been replaced by competition.
The
Commission is conducting this rulemaking prior to its review of any BOC
applications under Section 271, and therefore it cannot be certain precisely what
competitive
conditions will prevail in local exchange and access markets at the time that in-region
interLATA
services are authorized. In light of the statutory framework, however, the Commission
should
regard the regulation required by Section 272 as a temporary supplemental measure which,
in
conjunction with competitive forces, will protect against anticompetitive behavior. The
Commission should also recognize that these and other regulatory measures that might be
necessary and procompetitive while the BOCs retain substantial market power would be
unnecessary, and potentially anticompetitive, if that market power has been replaced by
robust
competition.
.
Page 5 .
II. Scope of the Commission's Authority over Intrastate InterLATA
Telecommunications Services (Paragraphs 20 - 27)
The
Commission may, as it tentatively concludes, exercise its authority under Sections
271 and 272 with respect to all interLATA telecommunications services, whether interstate
or
intrastate. The Telecommunications Act explicitly gives the Commission such authority.
Sections 271 and 272 grant the Commission authority over all "interLATA services,"
without
qualification. Section 3 of the Act defines "interLATA service" as "telecommunications
between
a point located in a local access and transport area and a point located outside such area."
47
U.S.C. § 153(21). "Local Access and Transport Area," or "LATA," is defined as a
contiguous
geographic area established before [the date of enactment of the Telecommunications Act
of
1996] by a Bell operating company such that no exchange area includes points within more
than
1 metropolitan statistical area, consolidated metropolitan statistical area, or State, except as
expressly permitted under the AT&T Consent Decree" or subsequently modified. 47
U.S.C
153(25).
The
Act's definition of LATA expressly recognizes that a LATA may comprise an area,
such as a metropolitan statistical area, smaller than a state. Thus when the Act defines
interLATA services to include telecommunications from a LATA to a point outside the LATA,
it
expressly recognizes that interLATA services may include telecommunications between
two
LATAs within a single state. It necessarily follows that in granting authority over
interLATA
telecommunications services, the Act grants the Commission authority over
telecommunications
between LATAs within a state.
This
conclusion is corroborated by the Act's express reliance upon the AT&T Consent
Page 6
Decree, where the LATA concept originated, and under which all LATAs were originally
laid
out. As part of the plan of reorganization of AT&T, the Consent Decree called for the division
of
all Bell territory in the United States into geographically-based "exchange" areas. U.S.
v.
Western Electric, 569 F.Supp. 990, 993 (D.D.C. 1983). The term "local access and
transport
area" was created as a replacement for "exchange area," shortly after the decree was entered
to
distinguish it from traditional telephone exchanges. Id. at 993-94, n.9. The Act's
definition of
"LATA" mirrors the definition of "exchange area" found in the decree. U.S. v. AT&T,
552
F.Supp. 131, 229 (D.D.C. 1982). Most LATAs laid out under the decree are based
upon
Standard Metropolitan Statistical Areas. 3 Thus, most LATAs comprise only parts of individual
states, and most states have more than one LATA. Only nine LATAs out of a total of 158
encompass an entire state. 4
The Consent Decree governed interLATA telecommunications,
whether inter or intrastate. The 1996 Act succeeds the decree, and in adopting the LATA
system
developed under the decree and in granting the Commission interLATA authority, the Act
confers upon the FCC the same scope of authority as that contained in the decree.
The grant by Sections 271 and 272 of limited intrastate authority
supersedes the
jurisdictional principle stated in Section 2(b) of the original Communications Act. Section
2(b)
was intended, when it was adopted in 1934, to govern other sections of the Act adopted at
the
Page 7
same time. Congress in 1934 could not have anticipated the AT&T Consent Decree or
Sections
271 and 272, which were adopted more than sixty years later. And when Congress adopted
Sections 271 and 272, which explicitly rely on a LATA system with multiple LATAs
within
single states, it necessarily overrode to that extent the jurisdictional principle stated in
Section
2(b). Nothing in the legislative history indicates that Congress intended Sections 271 and 272
to
be limited by Section 2(b). On the contrary, as the Commission notes, Congress gave the
Commission intrastate jurisdiction in other sections of the Act as well without discussing
Section
2(b). 5
Any
interpretation here of Section 2(b) to alter Sections 271 and 272 would, as the
Commission points out, lead to unexplainable gaps in the statute's coverage and other
nonsensical results. Congress could not have intended, for example, to open up the
intrastate
interLATA market immediately for BOC entry, without the carefully-devised entry
requirements
of Section 271, while at the same time establishing those requirements with respect to
interstate
interLATA entry. Nor could Congress have meant to defeat the safeguards carefully
imposed
under Section 272 by permitting the BOCs to engage in the behavior which Section 272
prohibits, as long as they do it within the individual states. See NPRM, ¶ 25. When, as
here,
amendments to legislative enactments cannot be harmonized with earlier sections of the
same
acts, "the new provisions should prevail as the latest declaration of legislative will." 1A J.
Page 8 . .
Sutherland, Statutes and Statutory Construction, § 22.34, p. 297 (5th ed. N. Singer
1993). 6
III. International Telecommunications Authority (Paragraph 32)
The
Commission tentatively concludes that Section 272 applies to both domestic and
international interLATA telecommunications services. NPRM, ¶ 32. The Department agrees.
As
the Commission notes, the 1996 Act defines "interLATA services" as "telecommunications
between a point located in a local access and transport area and a point located outside
such
area." 47 U.S.C. § 153(21). Any international telecommunications services provided by a
BOC
from its in-region states will fall within this definition. The definition does not distinguish
between domestic and international services, and no such distinction is contained in Section
272.
Under the AT&T Consent Decree, moreover, international services involving the U.S.
were
treated as covered by the interLATA prohibition, and there is no indication that Congress
intended to change this approach.
IV. Effect of Mergers on Extent of BOC Regions (Paragraph 40)
The
Commission asks whether, if two BOCs merge, the "region" to which Section 272
applies is the combined two regions of the formerly separate BOCs. It is. As the
Commission
notes, Section 272(i)(1) defines "in-region state" by reference to the region in which a BOC
was
authorized to operate pursuant to the AT&T Consent Decree. Section 153(4)(B) defines a
BOC
Page 9
to include its telephone exchange company successors or assigns. Thus, when any BOC is
merged into or acquired by another company, the successor becomes the original BOC for
purposes of the statute. When the successor company is a BOC, therefore, it both retains
its
original region from the Consent Decree and succeeds to the region of the acquired BOC.
In
effect, the successor BOC's "region" is now both its own original region and the region of
the
BOC it acquired. This answer is not only required by the statute's definitions, but is also the
only
one that make sense for the statute's practical administration. Once two BOCs are merged,
there
are no practical means for it to have different affiliates in two regions each separate from
the
former, but no longer extant, original BOC.
The
Commission also asks whether it should take any special steps to preclude
discriminatory treatment by one BOC in favor of the other's long distance affiliate in the
period
between agreement upon and consummation of a merger. We agree that there is legitimate
concern that a prospective merger might give rise to incentives to engage in
anticompetitive
conduct. A merger agreement, however, is only one of a wide variety of contractual
relationships
that might create such incentives. 7 We note that the antidiscrimination provisions of
Sections
201, 202 and 271 already apply to a BOC's relationship with its prospective merger partner.
Those sections govern the carrier's dealings with all long distance carriers alike, whether
Page 10 .
subsidiaries of prospective merger partners or not. The antidiscrimination provisions of
Section
272, on the other hand, apply only to a BOC's potential discrimination in favor of its own
affiliate. They do not apply to BOCs' relationships with affiliates of prospective merger
partners.
The Department believes that the
Commission must strictly enforce Sections 201, 202 and 271 in a premerger situation, and in
other contexts where incentives to behave anticompetitively
might arise. Because each such situation is more or less unique, however, we believe that
anticipatory rules may be less effective than continued case by case enforcement.
V. Structural Separation and Antidiscrimination (Paragraphs 55 -89)
The
Commission proposes numerous provisions to implement both Section 272's
structural separation requirements and Sections 272 and 271's antidiscrimination requirements.
The general direction of these interpretations appears to be that maximum separation should
be
required, and discrimination firmly prohibited. The Department agrees with this approach.
The
BOCs' affiliates might be permitted to enter the long distance business at a time when the
BOCs
still possess residual market power. As long as they do, they will have both incentive and
ability
to leverage that local exchange market power in ways that would harm competition and
consumers. The Commission must strictly enforce the Act's structural separation and
antidiscrimination provisions, in order to minimize such behavior.
Structural separation works best as a means to reduce the risk of cross
subsidies to the
same extent that maximum separation is achieved. Less than full separation reintroduces
the
very opportunities to misallocate costs that separation was intended to defeat. With respect
to
sharing of employees, for example, the Department agrees with the Commission that the
sharing
of administrative personnel, such as those in accounting, legal, and financial services, is
both
Page 11
prohibited by the Act and contrary to the Act's objective to prevent cross-subsidization.
Such
sharing would make cost misallocation possible even in a regime of extensive record keeping
by
the BOC and vigilant auditing by the Commission. The Commission could not practically
detect
any but a minuscule percentage of the occasions on which BOC personnel devoted
unrecorded
time to affiliate problems.
With
respect to discrimination, the Commission appears at several points to contemplate
very specific rules to implement the Act's antidiscrimination provisions. Such rules, by
supplying specific guidance, should assist in enforcement of the Act's provisions. But to
preclude an unintended subversion of those provisions, the Commission should point out that
its
rules are prohibitory, not permissive. Discrimination that is prohibited by the Act is not
permitted merely because it is not specifically mentioned in the rules. The Commission
cannot
realistically anticipate every form of improper discrimination by carriers with incentives to
discriminate. Yet the adoption of specific rules might incorrectly be interpreted by some
carriers
as permitting what is not specifically prohibited.
The
Commission tentatively concludes that a BOC may not transfer existing network
capabilities to a separate competitive services affiliate. Such a transfer is prohibited, the
Commission explains, by Section 272(a)'s requirement that all BOC "incumbent" local
exchange
carriers, including affiliates, be separate from affiliates that provide the competitive services.
The Department agrees that if a BOC transfers local exchange network functions, facilities
or
other capabilities to an affiliate, that affiliate becomes an incumbent local exchange carrier.
It
must meet the separation requirements laid out in Section 272.
No
other approach can adequately serve the precautionary purposes of Section 272's
Page 12 .
structural separation requirements. If affiliates provide their own local exchange network
facilities, for example, BOCs will have strong incentives to shift facilities maintenance,
upgrades
and expansion to the affiliates, while leaving their basic networks to suffer. The affiliates
might
then, if not subject to Section 272's requirements, seek to deny essential network access to
local
and long distance competitors. Competitors would be left with the inferior surviving parts of
the
network. Mixing local exchange with long distance functions would also open opportunities
for
BOCs unfairly to tie provision of their monopoly local services to customers' purchases of
their
long distance services.
VI. Enforcement of Sections 271 and 272 (Paragraphs 94 - 105)
The
Commission asks whether it should impose reporting requirements designed to assist
in enforcement of Sections 271 and 272. We believe that it should. We suggest that both
parent
BOCs and their in-region long distance affiliates be required to file periodic, publicly
available,
reports on two subjects. The first reports would concern all costs incurred by either a parent
or
an affiliate in transactions with the other, and costs arising from transactions with third
parties
dealing with both of them. Thus, all prices charged by the BOC to its affiliate, by the affiliate
to
the BOC, or by third party vendors to either the parent or the affiliate, if the vendor has a
relationship with both, will be reported. This information will substantially assist in the
detection of cost misallocations between BOCs and their affiliates.
The
second reports would concern the quantity, quality and timing of each service
provided by the parent to the affiliate, or by the affiliate to the parent. A BOC would, for
example, be required to report each request for service by its affiliate, the number of
circuits
requested and provided, the length of time between the request and its fulfillment, and the
Page 13
circuits' technical specifications. To the degree that services can be objectively defined and
measured, this information should assist in the detection of improper discrimination by a BOC
in
favor of its affiliate. We also encourage the Commission to consider other reporting
requirements that could assist in the detection of discrimination that might be more subtle,
even
though it is more competitively significant. However, we recognize the inherent difficulty
of
identifying and preventing such discrimination through regulatory measures.
We
believe that the risks to competition associated with cost misallocation and
discrimination are sufficiently great to warrant imposition of these reporting requirements.
Moreover, as we discuss below, we propose these requirements in lieu of dominant carrier
regulation that might be imposed on the affiliates. We believe that these requirements would
be
both more effective in preventing anticompetitive behavior, and less costly, than that
alternative.
The
Commission asks whether it may award damages under Section 209 of the Act, in
addition to the remedies specified in Section 271(d)(6)(A), for violations of Section 271,
and
whether it should in a 90-day complaint proceeding pursuant to Section 271(d)(6)(B) shift
the
burden of proof to the BOC once a complainant makes out a prima facie case. The answer
to
both questions, we believe, is yes. Nothing in Section 271(d)(6)(A) indicates that it provides
the
exclusive remedies for Section 271 violations. Thus, Sections 206 - 209, if their terms are
met,
continue to be available as statutory remedies for violations of Section 271.
The
burden of proof should be shifted in 90-day proceedings, if complainants make out
prima facie cases, simply because complaints would otherwise be impossible to resolve
within
the 90-day windows. Resolution of these cases will depend principally upon information
exclusively within the control of the defendant BOCs. If complainants had the burden of
proof,
Page 14
the cases could not be resolved until the complainants had been allowed extensive discovery.
But such discovery cannot be conducted within a 90-day window for the whole proceeding.
Shifting the burden to the BOCs will solve this problem by requiring them to take the initiative.
If they have exculpatory evidence, they will quickly produce it. If they fail to produce such
evidence, the Commission may reasonably conclude that the complaints are valid.
The
BOCs argue in their comments that a burden shifting rule will impose on them the
unpleasant task of responding to complaints that turn out to be unmeritorious. To the extent
the
BOCs are concerned about any complaint which fails to state even a facially acceptable
claim,
their concern can be addressed with measures aimed directly at the complainant. But a fear
of
frivolous filings cannot alone justify retaining the present burden allocation when, in a
90-day
decision cycle, that allocation will effectively render the complaint process meaningless. And
to
the extent the BOCs are concerned that facially valid complaints will turn out, upon
investigation, to be incorrect, the problem is an unavoidable consequence of the fact that
the
BOCs themselves have virtually all the information necessary to determine a complaint's
correctness. If complainants were required to produce sufficient evidence of their own to
prove
their complaints, the complaint process would effectively be vitiated.
Shifting the burden of proof is unlikely, moreover, appreciably to increase the
work the
BOCs must perform now to respond to legitimate discovery requests. They will have to
gather
essentially the same information and present that information in a slightly different format. If
the
BOCs are confronted with a number of similar complaints, they will, we assume, develop a
standard form of reply. The BOCs' responsibilities here should also be alleviated by
measures
which the Commission proposes to take--and should take--in CC Docket 96-150. BOC
Page 15
competitive services affiliates will be required to keep current books, in auditable form,
according to generally accepted accounting procedures. When the affiliates maintain such
books,
they should be readily able to respond to complaints concerning cost misallocation and
discrimination. 8
The
Commission also tentatively concludes that it should not employ a presumption of
reasonableness in proceedings concerning violations of Section 271, even if it determines
that
BOC affiliates are not dominant. The Department agrees with this conclusion. Once a BOC
is
granted authority to enter long distance, its incentives to comply with Section 271, and
particularly the checklist requirements of Section 271(c)(2)(B), will greatly diminish, as
the
Commission has recognized. 9 The Commission must therefore continue rigorously to
enforce
those requirements. Any presumption of reasonableness would almost certainly engender
among
the BOCs a sense of security that, absent truly egregious conduct, they may obstruct the
Page 16 .
development of local exchange competition with impunity. The Commission must not
impart
any such sense of security. It should in fact forcefully declare that it will not hesitate to
suspend
or revoke interLATA authority when it finds serious misconduct.
VII. Regulation of BOC
Affiliates as Dominant or Non-dominant Carriers (Paragraphs
15
-18, 108 - 162)
The
Commission asks whether BOC affiliates should be treated under the Commission's
rules as dominant carriers in long distance markets. As we have indicated above, so long as
the
BOCs retain market power in local exchange and access markets, that market power will
entail
serious risks of anticompetitive behavior. The regulatory requirements that the Commission
has
traditionally applied to dominant carriers, however, were not originally designed for
preventing
the types of anticompetitive behavior at issue here. They are less well suited for that
purpose
than some alternative measures, as suggested above. For this reason, the Commission should
not
adopt such regulation for the BOCs' interLATA affiliates.
In the
NPRM, the Commission correctly distinguishes between two types of market
power: the power of an affiliate to raise price in the interLATA market by reducing its
own
output of interLATA services, and the power of the affiliate's parent (the BOC) to harm
competition by using its market power in upstream markets for local exchange and access
services. We address these two types of market power separately, below.
A. Raising Prices By Restricting Output
The
Commission's regulation of dominant carriers was originally designed to constrain a
particular type of exercise of market power: The actions of a dominant firm to raise its prices
by
restricting its own output. Price regulation associated with dominant carrier status directly
Page 17 .
addresses that problem, by limiting the ability of dominant carriers to raise their prices above
the
levels established through this regulation.
The
NPRM correctly observes that the BOC affiliates will begin providing in-region
interLATA services with a zero market share, and seeks comment on whether an affiliate
could
quickly increase its share to the point where it could raise prices by restricting its output. In
the
Department's view, the Comments in this proceeding do not establish a likelihood that this
would occur in the short term, and the Commission need not adopt regulation at this time
to
prevent the exercise of this type of market power. If in the future the affiliate's market
share
threatens to rise to the point at which it could profitably raise prices by restricting its
output,
either as a result of anticompetitive behavior or for other reasons, the Commission can
adopt
adequate measures to deal with the problem at that time.
1. Market Definition
We
reach this conclusion, and we believe the Commission properly can reach the same
conclusion, without undertaking a precise definition of the relevant market(s) involved in
the
provision of the affiliate's interLATA services. In requesting comment on how to define
the
relevant product and geographic markets in this proceeding, NPRM, ¶ 115, the
Commission
explains that it seeks to define markets in order to determine whether BOC in-region long
distance affiliates will have market power. If they do, they would be classified as dominant
under the Commission's rules. NPRM, ¶114. But as we explain below, any attempt to
define
precise relevant markets in this context is likely to be difficult and ultimately pointless,
since
there is no basis in the record for concluding that in the near future, the BOC affiliate is likely
to
have the ability to raise prices by restricting its output, regardless of how the Commission
might
Page 18 .
define the relevant market(s) for interLATA services.
In the
absence of a present need to define markets, the Commission should refrain at this
time from doing so. Telecommunications markets are now in a transitional period.
Postponing
market definition determinations until there is a present need will allow the Commission to
base
its determinations on the most current information. A specific proceeding in which market
definitions are necessary will also permit the Commission to focus on a more specific and
definite universe of relevant facts. 10
The
Commission notes that market definition proceeds, in the first instance, from an
analysis of consumer demand substitution factors, i.e, from asking which products or
services,
and which providers of those products or services, are regarded by consumers as
reasonable
Page 19
substitutes for one another. From this perspective, the Commission points out that the
various
interstate, interexchange services may not be product substitutes for one another. NPRM, ¶ 118.
Moreover, consumers do not regard interexchange calls originating in different locations to
be
substitutes for one another. Thus, the relevant market could "be defined as all calls from
one
particular location to another particular location." NPRM, ¶ 123.
The
Commission properly recognizes, however, that for its regulatory purposes
examining markets at this level of detail would be impractical. NPRM, ¶¶ 118, 124. It would
be
a task of enormous complexity. The separate markets could number in the millions. For
the
Commission's purposes, moreover, all this effort would ultimately be pointless. For purposes
of
deciding whether and how to regulate interexchange carriers, as the Commission notes,
"economic factors and the realities of the marketplace should cause point-to-point markets
to
behave in a sufficiently similar manner to allow [the Commission] to evaluate broader,
more
manageable groups of markets." NPRM, ¶ 124.
These practical considerations may differ from considerations that may be
present in
particular antitrust cases. Because of these differences, markets defined by the Commission
may
properly differ from markets defined under the antitrust laws. We urge the Commission
explicitly to recognize this fact. The Department's Reply Comments in this proceeding are
offered to assist the Commission in its consideration of market definition issues, and do
not
necessarily reflect the analysis or conclusions that the Department might adopt in reviewing
any
specific transaction under the antitrust laws.
In
exercising its regulatory responsibilities, moreover, the Commission may need to
define markets more precisely in future proceedings. In its Interexchange NPRM,
the
Page 20
Commission proposed to define all interstate interexchange services as a single product
market,
and to define that market as a national market. NPRM, ¶¶ 118, 124; Policy and Rules
Concerning the Interstate, Interexchange Marketplace, CC Docket No 96-61, FCC 96-123
(rel.
March 25, 1996), ¶¶ 47, 51-52. In doing so, however, the Commission recognized that a
more
refined market definition would be appropriate if there are competitively significant
variations
within this market. Id. Narrower product markets, for example, would be appropriate
if "there is
or could be a lack of competitive performance" within the narrower markets. NPRM, ¶
118;
Interexchange NPRM, ¶ 47. This approach is not unreasonable, in our view, at least
for now.
Changes in the telecommunications industry are occurring today, however, that will likely
require
the Commission to define markets more precisely in the future. These changes are likely to
create differences in the practical alternatives available to consumers from one service to
another,
and from one geographic area to another. These changes may also result in significant
differences in the structure and performance of various product and geographic markets.
One
such change will be the entry of BOCs or other firms into the interexchange market.
Each of the BOCs has announced plans to provide interexchange services on a substantial
scale
within its region. With respect to out-of-region interexchange services, however, there are
substantial differences among the BOCs' entry plans and strategies, and each individual
BOC
appears to target for entry some out-of-region markets but not others. Because of these
differences, one might reasonably expect, for example, that Ameritech would be a
substantial
competitor in the provision of interexchange services to consumers in Chicago, but not in
Atlanta.
Similarly, if interexchange services increasingly will be offered as part of a
bundled
Page 21
local/long distance product, differences among locations in the extent of local competition
may
lead to significant differences in availability of interexchange substitutes. Time Warner,
for
example, might become a significant competitor in the provision of interexchange service
in
markets that it enters as a CLEC, but not in other markets where it has no local presence.
Analogous differences in competitive conditions are likely to develop with respect to
various
service offerings and customer groups, as well geographic areas. Competitive entry and
expansion is likely to occur more quickly with regard to some services for some customer
groups
than for other services and other customer groups.
Because of these differences, the practical alternatives that are available to
consumers, the
touchstone of market definition, will differ from market to market. An interexchange carrier
that
does not offer service to a consumer in a particular location cannot be regarded as an
effective
substitute for those carriers who do; robust competition in one city or in the provision of
one
service will do nothing to protect consumers in another city or consumers who need a
different
service.
This
does not mean that the Commission should attempt in this rulemaking to set out a
precise delineation of relevant markets. The purpose of this rulemaking is to establish a
regulatory regime for the separate affiliates required by Section 272. Attempting to
establish
different sets of regulations here for different markets within a single affiliate's region may be
impractical. It would require the Commission, for example, to create and police an
elaborate
system of accounting separations for the different markets. Because the Commission must
accommodate these practicalities, and questions of market definition aside, we believe that
the
Commission is not unreasonable in this proceeding to distinguish a BOC's provision of
Page 22 . .
interexchange service outside its region from provision of such service within its region.
Within
a BOC's region, as the Commission points out and as we discuss below, there is a
substantially
greater risk of anticompetitive behavior.
B. Harm to
Competition in Downstream Markets by Exercising Market Power
in Upstream Markets
The NPRM also notes that a second potential exercise of market power, arising
from the
BOC's market power in upstream markets, may be relevant in this rulemaking. The NPRM
correctly notes that this type of market power might be exercised by raising the cost of
downstream rivals or restricting those rivals' output through control over access to
bottleneck
facilities. NPRM ¶ 131. As we explain below, the discussion of this market power in the
NPRM
is, in significant respects, incomplete. Nonetheless, the Department does not believe that
the
regulation traditionally applied to dominant carriers would be appropriate in dealing with
this
type of market power in this context, where the Commission can more effectively address
the
problems by regulating the BOC directly and by regulating its relationship with its
interLATA
affiliate.
1. Market Definition
Since
we do not believe that the Commission's dominant carrier regulation should apply
to the operations of the BOCs' interLATA affiliates, we do not believe it is necessary for
the
Commission to resolve questions of market definition that would be relevant in assessing
the
risks that this type of market power would be exercised. Even if there is a substantial risk of
the
exercise of this type of market power, dominant carrier regulation is not the most effective
way
of dealing with that risk.
Page 23
If the
Commission concludes that it must define relevant markets in this context,
however, the approach outlined in the NPRM requires further refinement. For purposes of
assessing the competitive risks associated with the BOCs' control of upstream, bottleneck
facilities (i.e., local exchange and access facilities), the Commission's market definition
should
focus on this upstream market. If and when the BOCs lose their market power in this
upstream
market, they will also lose their ability and incentive to engage in anticompetitive
discrimination
and cost misallocation.
In
drawing the distinction between interLATA services that originate in-region and those
that originate out-of-region -- a distinction that reflects differences in the upstream market
power
of the BOC -- the NPRM seems implicitly to recognize that an analysis of the upstream market
is
needed. In considering the market definition of interLATA services, the Commission noted
that
"economic factors and the realities of the marketplace should cause point-to-point markets
to
behave in a sufficiently similar manner to allow [the Commission] to evaluate broader,
more
manageable groups of markets." NPRM ¶ 124. Similarly, in the context of local exchange
and
access services, the Commission seems to have concluded that in-region point-to-point
markets
could be expected to be "sufficiently similar" to justify similar regulatory treatment for all
of
them, just as out-of-region point-to-point markets could be "sufficiently similar" to one another
--
though not to in-region markets -- to justify comparable regulatory treatment at this time.
We
note again, however, that marketplace changes may require more refined market
definitions in the future. Local competition can be expected to emerge more quickly for
some
services and in some geographic areas than in others. As a result, markets that have
previously
been "sufficiently similar" to one another may be quite different from one another in the
future,
Page 24 .
and those differences may necessitate distinct regulatory approaches.
2. Exercise of Market Power
The NPRM discusses the potential risks from the exercise of upstream market
power,
either through cost misallocation or through actions that would "raise the costs" of the
BOCs'
downstream competitors. The Department agrees with many aspects of that discussion, but
the
conception of the competitive risks reflected in the NPRM is, in important respects, too
narrow.
The
NPRM observes that "improper allocation of costs by a BOC is of concern because
such action may allow a BOC to recover costs incurred by its affiliate to provide interstate
domestic interexchange services from subscribers to the BOC's local exchange and
exchange
access services. . . . For purposes of market power analysis, however, we are concerned
with
improper allocation of costs only to the extent it enables a BOC affiliate to set retail
interLATA
prices at predatory levels (i.e., below the costs incurred to provide those services), drive out
its
interLATA competitors, and then raise and sustain retail interLATA prices significantly
above
competitive levels." NPRM ¶ 135. In limiting its concerns to the possibility of predatory
pricing, the Commission's approach is seriously flawed. So limited, the Commission
would
ignore the most likely anticompetitive effects of cost misallocation.
In
addition to the predatory pricing strategy described in the NPRM, cost misallocation
may cause substantial harm to consumers, competition and production efficiency. With
respect
to consumers, cost misallocation can adversely affect prices for essential monopoly services.
Cost misallocation allows a provider of monopoly upstream services (i.e., local exchange
and
access services) to charge higher prices to the consumers of those services than it would
charge
absent the misallocation. Those prices are also higher than regulators would permit that
provider
Page 25
to charge if the regulators could effectively prevent such misallocation.
With
respect to competition and production efficiency, even if cost misallocation does not
result in below-cost pricing that drives downstream competitors (i.e., interexchange carriers)
out
of the market, it still does have adverse effects. Misallocation shifts market share and
profits
away from those downstream competitors and to the upstream monopolist engaged in the
misallocation. It does so even if the monopolist is less efficient than the competitors. Two
types
of economic harm follow. More of the relevant service is produced by the less efficient
monopolist, and less is produced by the more efficient downstream competitors, producing
immediate inefficiencies and wasted resources. And by artificially and inefficiently
depressing
competitors' profitability, the misallocation can be expected to reduce future investment by
those
competitors to improve or expand their networks, and to develop innovative technologies
and
services.
When it takes these broader harms into account, the Commission will
recognize that it
should then turn to a broader ensuing question. It asks in the NPRM whether the structural
safeguards in section 272, price cap regulation of the BOCs' access services, and proposed
accounting safeguards are sufficient to prevent cost misallocation that would result in
successful
predatory pricing. NPRM, ¶ 138. But the Commission must also ask the more important
question of whether regulation would prevent cost misallocation that would have the other
adverse consumer and economic effects identified above. From this broader perspective,
the
inadequacies of regulation as a means to prevent misallocation become more apparent.
The
Commission can and should attempt to reduce anticompetitive cost misallocations through
carefully devised rules, but it should be under no illusions that regulatory measures alone
will
Page 26 .
prevent competitively significant cost misallocations, so long as incentives remain to engage
in
such practices. Those incentives can be eliminated only when the local exchange market is
subject to robust competition.
The NPRM also discusses risks that BOCs might use their market
power in local
exchange and access services to raise their long distance rivals' costs or restrict their output.
These risks are substantial, and they cannot effectively be dealt with through regulatory
measures
alone. It is also important to recognize clearly the nature of these risks. In particular,
anticompetitive consequences will result if an upstream monopolist causes its downstream
rivals'
costs to exceed the costs that would prevail absent upstream market power. In a vertically
integrated firm, the downstream affiliate's economic cost of an input is equivalent to the
"competitive" price of that input; if rivals must pay more than a competitive price when
they
purchase inputs from the monopolist, they will be artificially disadvantaged. This is true
regardless of whether costs are "raised" from current levels, or from levels that might
otherwise
be anticipated in the future.
3. Regulation to Address This Market Power
In
Section VI above, concerning enforcement of Section 272, we suggest several
regulatory measures which are likely to reduce the risks that upstream market power would
be
exercised through some forms of anticompetitive cost misallocation and discrimination.
Both
BOCs and their affiliates should be required to file periodic, detailed reports concerning all
costs
arising from sources not independent of the other. Similar reports should concern the
quantity,
quality and timing of services provided by the BOC to its affiliate, and by the affiliate to its
parent. Affiliates should be required to maintain current, auditable books according to
generally
Page 27
accepted accounting principles. The burden of proof in 90-day complaint proceedings should
be
shifted to the BOC or its affiliate, and no presumption of reasonableness should attach in
complaints concerning violation of Section 271.
The
forms of regulation associated with dominant carrier status, however, are not as well
tailored to address the competitive risks involved in this context. Those rules were
designed
primarily to curb abuses of market power through the reduction of output by a dominant carrier.
But when the rules are applied to an affiliate in a downstream market, they are at best a
clumsy
tool for controlling vertical leveraging of market power by the parent, if the parent can be
directly
regulated instead. Indeed, applying those rules to affiliates might, under some
circumstances,
adversely impact competition in the long distance market. For example in the domestic
context,
use of the §214 approval process as a way to constrain leveraging would likely have to be
so
heavy handed that it could have undesirable consequences for competition as well. And
requiring BOC affiliates to file tariffs with substantial notice periods under Section 203
could
hinder the affiliates' pricing flexibility and facilitate implicit price coordination among long
distance carriers.
The
Commission in its NPRM and some commenters have suggested two respects in
which the dominant rules might have some impact on the exercise of vertically leveraged
market
power. Cost data filed by the affiliates with their FCC tariffs may assist in the detection of
cost
misallocation. Price cap regulation of the affiliates may deter BOCs from disadvantaging
long
distance competitors by reducing any supranormal profit the BOC's affiliate might earn as a
result. Both suggestions have some merit, but on balance we believe that any benefits to
be
gained from these measures are outweighed by their disadvantages.
Page 28
The
Commission must of course be able to track the assigned costs of transactions
between an affiliate and its parent if cost misallocation is to be detected. Existing
dominant
carrier rules are, however, at once too narrow and broader than necessary to achieve this
objective. Section 61.38 of the Commission's rules requires dominant carriers to file cost
studies
when they file tariff changes. But as a mechanism for detecting cost misallocation, Section
61.38
has several significant failings. Cost studies are filed only when tariffs are changed, and do
not
reflect costs incurred over regular time intervals. They do not contain any data about the costs
of
services provided to the parent by the affiliate. And Section 61.38 does not appear to
require
carriers to identify the sources of costs by individual vendors. Thus, an affiliate's complete
cost
study might leave all parties substantially in the dark as to which costs are attributable to its
LEC
parent.
On
the other hand, Section 61.38 would also require affiliates to report costs incurred
from sources independent of their parents. Those costs would be of little or no relevance to
any
cost misallocation question. Requiring affiliates to identify those costs with tariff filings
could
unfairly handicap them in relation to their long distance competitors. Both these
disadvantages
and the shortcomings of Section 61.38 would be resolved in the system of periodic cost
reports
we suggest above.
Price cap regulation for long distance affiliates presents a more complex
question. Such
regulation does very likely constrain pricing in local exchange by BOCs. In that market,
BOCs
provide an essential service and they face relatively little competition. If price cap regulation
of
long distance affiliates had a similar constraining effect, it could reduce the incentive for
BOCs
to impose costs on long distance competitors. The affiliates might not be able to retain all of
the
Page 29
financial benefit they might otherwise derive. But the impact of price cap regulation on
affiliate
pricing, and therefore its deterrence effect, is not so clear. The extent to which such
regulation
would initially constrain the affiliate's pricing and profits cannot be determined at this time,
and
after price caps are initially established, the affiliates likely would be permitted substantial
pricing flexibility. As the Commission recognizes, moreover, "price regulation would not
prevent the affiliate from profiting from the BOC's raising of rivals' costs through increased
market share." NPRM, ¶ 132.
On
the other hand, price cap regulation of affiliate rates could entail significant
disadvantages. It will interfere with market determined pricing by the affiliates, resulting in
less
efficient investment and service decisions. It will be costly to the Commission and to
litigants
before the Commission, as it encourages extensive rent seeking by those litigants. And it
may
facilitate implicit price coordination among long distance carriers. On balance, we believe,
these
disadvantages outweigh any marginal benefit to be gained from price cap regulation of the
affiliates.
By
relying on measures tailored to address the problems at hand, the Commission would
be following an approach similar to the one it took in its Foreign Carrier Entry Order.
Market
Entry and Regulation of Foreign-affiliated Entities, 11 FCC Rcd 3873 (1995). There,
the
Commission considered the means it should use to regulate international carriers which
themselves operated in relatively competitive markets, but which were affiliated with
foreign
monopoly carriers. The Commission recognized that these carriers' market power resulted
not
from their own positions, but from their parents' "control of bottleneck services or facilities
on
the foreign end," control which could be "leveraged on international routes to the detriment
of
Page 30
unaffiliated U.S. carriers." Id. at 3917, 3912. Although the Commission declared that
U.S.
international carriers with monopoly affiliates would be dominant, it exempted them from
several of its dominant carrier rules. They were not, for example, required to file cost
support
data with their tariffs. The benefits of this requirement, the Commission held, are
"outweighed
by the burden imposed." "Moreover," the Commission continued, "competition in the market
for
international services is a better constraint on unreasonable prices than Commission review of
a
foreign carrier's cost support showing." Id. at 3973. For that reason, the Commission
considered
it appropriate to bar foreign entry altogether where foreign markets had not been
sufficiently
opened to competition.
The
approach the Commission should take here differs slightly from its approach in the
Foreign Carrier Entry Order because some factors which underlay that decision are
not present
here. There, the parents' bottleneck services and facilities were not themselves subject to
U.S.
regulation, and the Commission's ability to regulate terms of market entry by the foreign
carriers,
which the Commission gained through application of its dominant carrier rules, was a
central
concern. Neither factor obtains here. So the Commission need not and should not start from
the
same baseline, applying the dominant carrier rules unless otherwise stated. But the reasons
why
the Commission adopted a selective approach fully apply here. Market power derived
solely
from vertical leverage is not the type of market power for which the dominant carrier rules
were
designed.
.
Page 31
Respectfully submitted,
David Turetsky
Deputy Assistant Attorney General Donald J.
Russell, Chief
Antitrust Division Telecommunications Task Force
Antitrust Division
John Hayes Michael J. Hirrel
Economist Scott B. Murray
Economic Regulatory Section Attorneys
Telecommunications Task
Force
Antitrust Division
U.S. Department of Justice
555 4th Street, N.W.
Room 8104
Washington, D.C. 20001
(202) 514-5621
August 30, 1996
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