sibling rivalry: the emergence of competition among the baby bells

14
MANAGERIAL AND DECISION ECONOMICS, VOL. 16,479-492 (1995) Sibling Rivalry: The Emergence of Competition Among the Baby Bells William F. Shughart I1 Uniwrsity of Mississippi, MS, USA The Modification of Final Judgment (MFJ) prohibits the seven regional Bell operating companies (RBOCs) spun off by AT&T from competing with one another in various markets ‘adjacent’ to the local telephone exchange. I have examined the competitiveness of three of these a4acent markets (cellular telephone, paging services, and yellow pages publishing) since divestiture in order to assess the likelihood of collusion among the RBOCs. On the basis of a decade of post-divestiture experience, I find the prospect of collusion to be remote and, hence, the probability of anticompetitive effects from lifting the MFJ to be vanishingly small. INTRODUCTION I have been asked to assess the likelihood that the Regional Bell Operating Companies (RBOCs), if freed from the line-of-business re- strictions of the Modification of Final Judgment (MFJ), could obtain monopoly power in markets adjacent to the local telephone exchange. I con- clude that there is no likelihood of such monopol- ization either through independent action by the RBOCs or collusion among them. On the basis of a decade of post-divestiture experience, it is ap- parent that no one RBOC is large enough to monopolize either those markets in which it is a buyer (central office switching equipment, for in- stance) or those in which it would be a seller (such as interexchange services) if the MFJ’s line- of-business restrictions were lifted. Furthermore, substantial regulatory safeguards have become available since 1984 to prevent any unilateral action that might result in a lessening of competi- tion. While the history of the Bell System may have made concerns about collusion between the RBOCs understandable at the time the MFJ was issued, no evidence of collusion has materialized in the ten years since. The seven RBOCs have consistently acted independently since the breakup of AT&T, competing vigorously with one another at every opportunity. I find the prospect of collusion to be remote and, hence, CCC 0143-6570/95/040479-14 0 1995 by John Wiley & Sons, Ltd. the probability of anticompetitive effects from lifting the MFJ to be vanishingly small. Thus, I strongly support removing the line-of-business re- strictions imposed by Judge Greene. THE ANTICOMPETITIVETHEORIES UNDERLYING THE MFJ Since 1984, when the MFJ went into effect, its line-of-business restrictions have prohibited the RBOCs from offering interexchange telecommu- nications services, from manufacturing telecom- munications equipment, and from distributing telecommunications equipment other than so- called customer premise equipment (CPE). Addi- tional MFJ restrictions imposed on RBOC parti- cipation in information services and non-telecom- munications businesses have been lifted already. The fears that led to the line-of-business re- strictions can be classified under two broad head- ings. These are cross-subsidization and foreclo- sure. Cross-subsidization involves the REBOW strate- gic use of their control over local exchange facili- ties to finance predatory behavior in adjacent markets or to increase returns from regulated businesses. This could be accomplished, first, by shifting disproportionate shares of the common costs of supplying related services, say local and

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MANAGERIAL AND DECISION ECONOMICS, VOL. 16,479-492 (1995)

Sibling Rivalry: The Emergence of Competition

Among the Baby Bells William F. Shughart I1

Uniwrsity of Mississippi, MS, USA

The Modification of Final Judgment (MFJ) prohibits the seven regional Bell operating companies (RBOCs) spun off by AT&T from competing with one another in various markets ‘adjacent’ to the local telephone exchange. I have examined the competitiveness of three of these a4acent markets (cellular telephone, paging services, and yellow pages publishing) since divestiture in order to assess the likelihood of collusion among the RBOCs. On the basis of a decade of post-divestiture experience, I find the prospect of collusion to be remote and, hence, the probability of anticompetitive effects from lifting the MFJ to be vanishingly small.

INTRODUCTION

I have been asked to assess the likelihood that the Regional Bell Operating Companies (RBOCs), if freed from the line-of-business re- strictions of the Modification of Final Judgment (MFJ), could obtain monopoly power in markets adjacent to the local telephone exchange. I con- clude that there is no likelihood of such monopol- ization either through independent action by the RBOCs or collusion among them. On the basis of a decade of post-divestiture experience, it is ap- parent that no one RBOC is large enough to monopolize either those markets in which it is a buyer (central office switching equipment, for in- stance) or those in which it would be a seller (such as interexchange services) if the MFJ’s line- of-business restrictions were lifted. Furthermore, substantial regulatory safeguards have become available since 1984 to prevent any unilateral action that might result in a lessening of competi- tion.

While the history of the Bell System may have made concerns about collusion between the RBOCs understandable at the time the MFJ was issued, no evidence of collusion has materialized in the ten years since. The seven RBOCs have consistently acted independently since the breakup of AT&T, competing vigorously with one another at every opportunity. I find the prospect of collusion to be remote and, hence,

CCC 0143-6570/95/040479-14 0 1995 by John Wiley & Sons, Ltd.

the probability of anticompetitive effects from lifting the MFJ to be vanishingly small. Thus, I strongly support removing the line-of-business re- strictions imposed by Judge Greene.

THE ANTICOMPETITIVE THEORIES UNDERLYING THE MFJ

Since 1984, when the MFJ went into effect, its line-of-business restrictions have prohibited the RBOCs from offering interexchange telecommu- nications services, from manufacturing telecom- munications equipment, and from distributing telecommunications equipment other than so- called customer premise equipment (CPE). Addi- tional MFJ restrictions imposed on RBOC parti- cipation in information services and non-telecom- munications businesses have been lifted already.

The fears that led to the line-of-business re- strictions can be classified under two broad head- ings. These are cross-subsidization and foreclo- sure.

Cross-subsidization involves the REBOW strate- gic use of their control over local exchange facili- ties to finance predatory behavior in adjacent markets or to increase returns from regulated businesses. This could be accomplished, first, by shifting disproportionate shares of the common costs of supplying related services, say local and

480 WILLIAM F. SHUGHART II

long-distance telephone calls, to the local ex- change’s rate base. Where local telephone rates are set by regulators based on the costs of provid- ing service, some of the costs of supplying long- distance service would in this hypothetical exam- ple be passed on to consumers in the form of higher rates for local telephone service. Because it would thereby earn higher returns from regu- lated operations, a RBOC could profitably charge below-cost long-distance rates. Such cross-sub- sidization may allow the RBOC to drive out exist- ing rivals and to strategically deter the entry of new ones, enabling it eventually to earn supra- competitive returns in the long-distance market.

The MFJ assumes that the RBOCs may also be able to subsidize competitive businesses and cir- cumvent rate regulation through a form of self- dealing. Suppose the RBOCs are permitted to manufacture telephone switches, for example. An incentive would then exist to set the intracom- pany (transfer) prices of switches or other inter- nally supplied inputs above their marginal pro- duction cost. These above-marginal-cost input prices would be added, at least in part, to the local telephone exchange’s rate base, and conse- quently shifted forward to local rate payers. Self- dealing of this sort was in fact one of the major allegations of anticompetitive behavior levied against the old vertically integrated Bell System?

The second fear underlying the MFJ’s line-of- business restrictions, namely foreclosure, assumes that the RBOCs could deny rivals in adjacent markets access to the local exchange, or grant access at discriminatory prices. Through such dis- crimination, a RBOC could theoretically raise the cost of competitor’s products and services or drive competitors from a market entirely, enabling the RBOC to increase its own profits in that market.

None of these concerns necessarily depends upon collective action by the RBOCs. Neverthe- less, the possibility of collusion among the RBOCs was thought to add significantly to the competi- tive risk of allowing RBOCs into adjacent mar- kets. Concerns about RBOC collusion extended particularly to manufacturing markets. The RBOCs, it has been said, might ‘act in concert with respect to manufacturing and purchasing’ and ‘enter into explicit or implicit agreements with each other regarding specifications or inter- connection req~irements’.~ Such cooperation, the theory goes, would allow the RBOCs to drive other competitors out of adjacent markets and

then to divide those markets among themselves, enabling the realization of supracompetitive pro- fits? Similar strategies might be employed in in- terexchange markets, where FtBOCs could theo- retically combine to raise the costs of rival carri- ers and drive them from the market.

In theory, collusion might also facilitate cross- subsidization. Absent collusion, a single RBOC‘s effort to raise the prices of inputs to exchange service above marginal cost would likely cause other producers of the inputs to undercut that RBOC‘s prices. Likewise, regulators could readily detect a RBOC‘s padded costs through compar- isons with benchmark cost information obtained from the other six RBOCs and non-RBOC local exchange carriers. If, however, the m0Cs agreed not to offer inputs at competitive prices or to report similarly inflated costs, it would be some- what easier to conceal and sustain cross-subsidies.

OBSTACLES TO ANTICOMPETITIVE CONDUCT

Concerns about cross-subsidy, foreclosure, and collusion may have seemed well founded at a time when the Bell System dominated nearly all telecommunications markets and overwhelmed regulators with its sheer size. Today, however, the fears that prompted the line-of-business restric- tions are comprehensively addressed by regula- tion and market forces.

Since 1984, incentive-based rate regulation has been adopted at the federal level and has become much more widely used at the state level. So-called price-cap regulation, for instance, limits allowable rate increases to a specifled percentage that only partially offsets increases in the overall rate of inflation. Such regulatory pricing formulas create stronger incentives to economize on the costs of providing service than older forms of rate-of-re- turn regulation by limiting the extent to which cost increases can be passed on to consumers in the form of higher prices. Structural and account- ing separation policies have also been adopted that sharply reduce opportunities to evade rate regulation through cross-subsidization. In addi- tion, non-RBOC suppliers of telephone equip- ment and other inputs provide regulators with competitive benchmarks for determining the rea- sonableness of the RBOCs’ internal transfer prices.

THE EMERGENCE OF COMPETITION AMONG THE BABY BELLS 481

Equal access and interconnection rules address fears that the RBOCs might deny competitors access to the local exchange, provide them with inferior access, or charge them discriminatory prices. The Federal Communications Commission (FCC), for instance, has established technical and performance standards that CPE must meet in order to be connected to the local network. If a rival's equipment meets these standards, the RBOC cannot deny connection. The FCC also requires that all telcos offer local service unbun- dled from CPE. This provision precludes the RBOCs from either requiring customers to pur- chase RBOC-manufactured equipment in order to receive local service, or charging customers more for local service if the equipment is not manufactured by an affiliated supplier. Disclosure and structural separation requirements protect against the possibility that the RBOCs will afford their own competitive business operations prefer- ential access to network or customer information. These rules make the possibility of foreclosure remote.

Finally, opportunities to cross-subsidize unregu- lated operations, or to deny competitors equal access, promise to be constrained even more tightly by actual and potential competition in the supply of local telephone service. The develop ment of competitive access providers, wireless telephone technology, and other methods of by- passing the local exchange, as well as the major interexchange carriers' steps toward building their own local networks, cast doubt on the whole notion that a local exchange 'bottleneck' exists in the first place.

IMPEDIMENTS TO COLLUSION AND MARKET EXPERIENCE

By erecting formidable barriers to cross-subsidi- zation and foreclosure, the regulatory and market developments discussed above indirectly address many of the concerns about collusion among the RBOCs. In addition, anticompetitive collusion is directly forbidden by federal and state antitrust laws, violation of which carries substantial penal- ties. Civil and criminal penalties for violations of the Sherman Act, for example, include treble damages: corporate h e s of up to $10 million (along with personal fines of as much as

$350000),6 and mandatory minimum prison sen- tences?

In addition, theories that the RBOCs might collude to effectively revive the Bell System and its supposed anticompetitive practices overlook practical realities. The RBOCs are no longer part of a single entity; they are seven independent and competitive companies. This simple fact renders successful collusion highly improbable.

Firms collude in order to increase their joint profits. This same profit motive provides powerful incentives for the individual members of a price- fixing conspiracy to cheat on their agreement: One cartel member can increase its own profits at the expense of the others by secretly expanding output and cutting price. Hence, for collusion to be successful, the conspirators might be able to detect and to punish the inevitable cheating on their agreement; they must also act collectively to deter the entry of new rivals who wish to share in the cartel's profits!

Successful collusion also requires that the mem- bers of a price-fixing conspiracy agree on a method of dividing the market among themselves. Assign- ing geographic territories is the most likely method of market division because extra-terri- torial sales then become prim facie evidence of cheating (Stigler, 1964). Indeed, the MFJ Court has speculated that the RBOCs would engage in just this sort of territorial division if allowed into telecommunications manufacturing markets?

Finally, it is probable that successful collusion would necessarily involve several RBOCs, not just two of them. The RBOCs collectively switch 85% of all interexchange calls and control 77% of all customer access lines. But the largest RBOC, Bell Atlantic, switches only 16% of all interstate calls and controls only 12.5% of all access lines; South- western Bell accounts for less than 9% of inter- state calls and access lines. (See Tables 1 and 2). Individual shares of this magnitude are insuffi- cient for effective predation in adjacent markets;" even a combination of two RBOCs likely would be inadequate. Only by combining several RBOCs' shares of exchange access or input purchases, and several RBOCs' war chests for subsidizing entry deterrence, could the RBOCs create a genuine anticompetitive threat.

Evidence of Rivalry It obviously is impossible to prove (or disprove)

482 WILLIAM F. SHUGHART I1

Table 1. RBOC Shares of Tier I Interstate Switched Access Minutes, 1991

Company

Bell Atlantic BellSouth "Ex Ameritech US West Southwestern Bell Pacific Telesis Total

Shire (46)

15.9 15.2 13.3 11.4 11.3 8.9 8.1

84.1

Some: US Federal Communications Commission (1993, pp. 212-13)

that the RBOCs could not successfully engage in anticompetitive collusion if the remaining MFJ restrictions were removed. Nevertheless, we now have up to a decade of experience with RBOC participation in adjacent markets such as cellular services, paging services, and publication of yel- low page directories. Concerns about RBOC col- lusion can be tested directly against this experi- ence.

If the RBOCs are able to overcome the formidable obstacles to collusion in adjacent mar- kets, one would expect them to agree to remain in their home territories, or at least to eschew inter-RBOC competition. Evidence of RBOC ver- sus RBOC competition does not absolutely rule out the possibility of collusion, but it does make the existence of such collusion significantly less likely. Inter-RBOC rivalry also complicates the negotiation and enforcement of future collusive agreements, making fears of anticompetitive cooperation that much less plausible.

Table 2. RBOC Shares of Local Exchange Callers (LEC) Access Lines, 1992

Company Share (%)

Bell Atlantic BellSOUth Ameritech "Ex Pacific Telesis us west Southwestern BeU Total

12.5 125 11.7 10.8 10.0 9.2 8.7

75.4

sourcC: US Telephone Association 1993, pp. 21-7.

In cellular telephone services, there is substan- tial RBOC versus RBOC competition in a num- ber of markets within each RBOC region. (See Table 3). As of 1992, for instance, Southwestern Bell competed against Ameritech in Illinois, Indi- ana, and Missouri; against Bell Atlantic in Mary- land, Virginia, and the District of Columbia; and against " E X in Massachusetts. To give an- other example, BellSouth faced competition within its home region from Bell Atlantic and Pacific Telesis, but competed against Ameritech and Pacific Telesis in their home regions.

Similar competition appears to exist in paging and yellow pages publishing markets. In fact, the incidence of RBOC versus RBOC competition is even greater in paging services than in cellular communications. As shown in Table 4, the RBOCs compete with one another in all but two of the nation's 105 largest metropolitan areas. Similarly, as shown in Table 5, six of the seven RBOCs face substantial competition in yellow pages publishing from at least one other RBOC that has entered their home-region market. This competition is hard evidence that the RBOCs will not collude along regional lines.

The RBOCs are also positioning themselves to compete against one another in the delivery of voice, video and data transmission services at the local level. Alliances with cable television compa- nies provide the RBOCs with the ability to supply these services outside their home regions. In 1993, all the RBOCs except Ameritech announced plans to enter into alliances with cable TV companies outside their home regions." While proposed al- liances have not always been consummated, such developments demonstrate that competition between RBOCs will extend even to the RBOCs' local telephony markets.'* This evidence that RBOCs do not collude with

one another to impede competition is reinforced by shifts in the RBOCs' individual shares of the cellular market. If the RBOCs have been collud- ing, one would expect each individual RBOC's share of total RBOC cellular subscribership to remain relatively stable over time. The facts do not show such share stability, however, as evi- denced by the information displayed in Fig. l. Between 1988 and 1992, Pacific Telesis' share of total RBOC cellular telephone subscribers fell from 22% to 13%. At the other extreme, South- western Bell's share rose from 19% to 25%. This

THE EMERGENCE OF COMPETITION AMONG THE BABY BELLS 483

Table 3. RBOC versus RBOC Competition in Cellular Markets, 1992

Reaon State

Ameritech WI WI WI WI WI WI MI MI OH OH OH OH OH OH OH IL IL IL IL IL IL IL

Bell Atlantic

Bell South

" E X

Pacific Telesis

DC MD VA

sc GA GA GA GA

MA MA MA MA MA RI RI

CA CA

Southwestern MO Bell MO

MO MO

Mprket location

Milwaukee Madison Racine Janesville Kenosha Sheboygan Detroit F h t Cincinnati Columbus Dayton Hamilton Springfield OH 4 OH 8

Springfield Champaign Decatur Bloomington IL 6 Gary-Hammond

Washington Baltimore

Chicago

VA 10-B1

Columbia Atlanta Athens GA 3 GA 4-B1

Boston New Bedford Pittsfield Worcester M A 2 Providence R I l

Los Angeles San Diego

St. Louis MO 8 MO 18 MO 19

RBOC oompetitor

liccnscc

BellSouth BellSouth BellSouth BellSouth BellSouth BellSouth PacTel PacTel PacTel PacTel PacTel PacTel PacTel PacTel PacTel Southwestern Bell Southwestern Bell Southwestern Bell Southwestern Bell Southwestern Bell Southwestern Bell Southwestem Bell

Southwestern Bell Southwestern Bell Southwestern Bell

Bell Atlantic PacTel PacTel PacTel PacTel

Southwestern Bell Bell Atlantic Bell Atlantic Southwestern Bell Southwestern Bell Bell Atlantic Bell Atlantic

BellSouth us west

Ameritech Ameritech Ameritech Ameritech

Source: Cellular Telecommunications Industry Association (1992)

Tab

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ver

sus

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ices

, 105

Lar

gest

Met

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993

No. 1 2 3 4 5 6 7 8 9 10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

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te

New

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alifo

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ouri

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ania

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Was

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Miss

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In

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Tab

le 4

. R

BOC

ver

sus

RBO

C C

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titio

n in

Pag

ing

Serv

ices

, 105

Lar

gest

Met

ropo

litan

Sta

tistic

al Ar

eas, 1

993

(Con

t.)

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

Ala

bam

a C

onne

ctic

ut

Virg

inia

N

ew Y

ork

Okl

ahom

a Te

nnes

see

Nor

th C

arol

ina

Ohio

Haw

aii

Florida

Ohi

o N

ew Y

ork

Indi

ana

Mas

sach

uset

ts

Penn

sylv

ania

O

klah

oma

Penn

sylv

ania

V

irgin

ia

Florida

Nor

th C

arol

ina

New

Jer

sey

Mas

sach

uset

ts

Neb

rask

a Ohio

Sout

h C

arol

ina

Del

awar

e N

ew J

erse

y N

orth

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a Florida

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ia

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s M

assa

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n

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orfo

lk

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any

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ahom

a City

N

ashv

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ensb

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New

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Hon

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kron

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ry-H

ammo

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ntow

n R

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N

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runs

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G

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t W

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ng B

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h R

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gh

Wes

t Pal

m B

each

h

ar

d

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no

AU

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N

ew B

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ngst

own

Bel

lSou

th

"E

x

Bell

Atla

ntic

"-EX

sw Bel

l B

ells

outh

B

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outh

A

mer

itech

"E

x

Bel

lsou

th

Am

erite

ch

"E

x

Am

erite

ch

"E

x

Bell A

tlant

ic

SW B

ell

Bell

Atla

ntic

Bell A

tlant

ic

Bel

lsou

th

Bel

lsou

th

"E

x

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x

Am

erite

ch

us w

est

Am

erite

ch

Bel

lsou

th

Am

erite

ch

Bell

Atla

ntic

"E

x

Bel

lsou

th

Bel

lSou

th

PacT

el

PacT

el

sw Be

ll "E

x

sw Bell

Bel

lSou

th

Bel

lSou

th

Bell A

tlant

ic

Bel

lSou

th

Bel

lSou

th

Bel

lSou

th

Bel

l Sou

th

Am

erite

ch

Bel

lSou

th

Bel

lSou

th

Bel

lSou

th

Am

erite

ch

Bel

lsou

th

Am

erite

ch

Bel

lsou

th

Bel

l Atla

ntic

B

ellS

outh

B

ell A

tlant

ic

Bel

l Atla

ntic

B

ellS

outh

B

ellS

outh

B

ell A

tlant

ic

Bel

lSou

th

Am

erite

ch

Bel

lSou

th

Am

erite

ch

Bel

lsou

th

Am

erite

ch

Bell A

tlant

ic

Bell A

tlant

ic

Bel

lsou

th

Bel

lSou

th

Bel

lsou

th

Bel

lSou

th

Bel

lsou

th

Bel

lsou

th

Bel

lsou

th

PacT

el

sw Be

ll B

ell S

outh

Pa

cTel

Pa

cTel

Pa

cTel

Pa

cTel

B

ells

outh

Pa

cTel

PacT

el

Bellsouth

"E

x

Bel

lSou

th

sw Be

ll B

ellS

outh

Pa

cTel

B

ellS

outh

B

ellS

outh

Pa

cTel

Pa

cTel

sw

Bell

PacT

el

Bel

lsou

th

PacT

el

PacT

el

PacT

el

Bel

lSou

th

Bel

lsou

th

sw Bel

l Pa

cTel

Pa

cTel

Pa

cTel

Pa

cTel

Pa

cTel

sw

Bell

PacT

el

PacT

el

SW B

ell

SW B

ell

sw Bel

l

sw Bell

sw Bel

l Pa

cTel

Pa

cTel

Pa

cTel

sw Be

ll Pa

cTel

Pa

cTel

SW

Bel

l

sw Bell

sw Be

ll us

Wes

t

PacT

el

sw Bel

l

sw Be

ll sw

Bell

sw Be

ll sw

Bell

sw Bel

l

sw Be

ll

sw Bel

l sw

Bell

sw Bel

l

E 4

W E

us W

est

P

W

o\

Tab

le 4

. pR

BO

C~e

rsus

GO

C C

om

pet

itio

nin

P& Se

rvic

es, 1

05 L

arge

st M

etro

polit

an S

tatis

tical

Are

as, 1993 (Cont.)

78

79

80

81

82

83

a4

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

100

101

102

103

104

105

Michigan

Lam

ing

Am

erite

ch

Am

erite

ch

Bel

lSou

th

PatT

el

sw Bel

l Te

nnes

see

Kn

de

B

ellS

outh

B

ellS

outh

Pa

cTel

sw Bell

Loui

sian

a B

aton

Rou

ge

Bel

lSou

th

BellSouth

PacT

el

sw Bel

l Te

xas

El P

as0

sw Be

ll

Bel

lSou

th

PacT

el

sw Bell

Was

hing

ton

Taco

ma

us W

est

Bel

lSou

th

PacT

el

us W

est

Ala

bam

a M

obile

B

ellS

outh

B

ellS

outh

Pa

cTel

Pe

nnsy

lvan

ia

Har

risbu

rg

Bel

l Atla

ntic

B

ell A

tlant

ic

Bel

lSou

th

Tenn

esse

e Jo

hnso

n C

ity

Bel

lSou

th

Bel

lSou

th

PacT

el

New

Mexico

Alb

uque

rque

us

wes

t B

ellS

outh

Pa

cTel

sw Bell

Ohi

o C

anto

n A

mer

itech

A

mer

itech

B

ellS

outh

Te

nnes

see

Cha

ttano

oga

BellSouth

Bel

lSou

th

Kan

sas

Wic

hita

sw

Bell

Bel

lSou

th

PacT

el

sw Be

ll

Sout

h C

arol

ina

Cha

rlest

on

Bel

lsou

th

Bel

lSou

th

PacT

el

Puer

to R

ico

san Juan

NA

N

A

Artansas

Littl

e R

ock

sw Bel

l B

ellS

outh

Pa

cTel

sw

Bell

Michigan

Sagi

naw

A

mer

itech

A

mer

itech

B

ells

outh

Pa

cTel

So

uth

Car

olin

a C

olum

bia

Bel

lSou

th

Bel

lSou

th

PacT

el

Cal

iforn

ia

Bak

ersf

ield

P8

cTel

Be

llSoU

th

PacT

el

sw Bell

Ncv

ada

Las

Veg

as

PacT

el

Bel

lSou

th

PacT

el

sw Bel

l

Indi

ana

Fort W

ayne

A

mer

itech

A

mer

itech

B

ellS

outh

Iow

a D

aven

port

us west

Am

erite

ch

Bel

lsou

th

Penn

sylv

ania

Y

ork

Bell A

tlant

ic

Bel

lSou

th

sw Bel

l Lo

uisi

ana

Shre

vepo

rt B

ells

outh

B

ellS

outh

Pa

cTel

sw

Bell

TCXaS

Be

aum

ont

sw Bel

l BellSouth

sw Bell

Iow

a D

es Moines

us W

est

Bel

lSou

th

sw Bell

us W

est

lllin

0i.S

Pe

oria

A

mer

itech

A

mer

itech

B

ellS

outh

V

irgin

ia

New

port

New

s B

ell A

tlant

ic

Bell A

tlant

ic

Bel

lSou

th

PacT

el

Penn

sylv

ania

La

ncas

ter

Bell

Atla

ntic

B

ellS

outh

sw

Bell

us W

est

us W

est

Sow

er: B

IA P

ublic

atio

ns (1

993)

. N

ore:

The

sale

of S

outh

wes

tern

Bell's

prim

ary

pagi

ng s

ervi

ce s

ubsi

diar

y, M

etro

med

ia P

agin

g Se

rvic

es, a

nd th

e sa

le o

f Pa

cTel

's pr

imar

y pa

ging

se

rvic

e su

bsid

iary

, Pac

Tel P

agin

g, a

re pending.

THE EMERGENCE OF COMPETITION AMONG THE BABY BELLS 487

Table 5. RBOC versus Competition in Yellow Pages Publishing within Selected Metropolitan Statistical Areas, 1993

Ameritech

BellSouth

"Ex

Pacific Telesis

Southwestern Bell

Fort Wayne, IN

Indianapolis, IN Dayton, OH

Chicago, IL

Louisville, KY-OH Johnson City, TN-VA Tampa, FL Memphis, TN-AR-MS Birmingham, AL Mobile, AL

Bridgeport, CT Albany, NY New York, NY-NJ

Los Angela, CA San Diego, CA San Jod, CA Sacramento, CA h a r d , CA Las Vegas, NV S.F.-Oaklad, CA

St. Louis, MO-IL Oklahoma City, OK Beaumont, TX

Houston, TX Dallas-Ft. Worth, TX

Southwestern Bell us West us west us west

Ameritech Bell Atlantic Southwestern Bell Southwestern Bell Southwestern Bell Southwestern Bell

us west us West us west, Bell Atlantic

" E X "Ex "Ex "Ex "Ex Southwestern Bell us West

Ameritech us west us west US West US West

US West Davenport, IA-IL Ameritech Omaha, NE-JA Southwestem Bell

Note: Metropolitan areas are selected from the 105 largest Metropolitan Statistical Areas (MSAs) in 1980. Some: Yellow Pages Publishers Association (1993).

instability in the RBOCs' market shares over time is at odds with the possibility of a collusive agree- ment in cellular services. Rather, the evidence is consistent with the existence of spirited competi- tion between the RBOCs in this market.

Regression Analysis

The MFTs assumption that the RBOCs will col- lude also can be tested by examining the prices charged in markets where they compete head-to- head. If the RBOCs were colluding successfully, then prices should be higher in those geographic areas that are served by two or more of them, as compared to areas served by a single RBOC and

a non-RBOC competitor or competitors. This possibility was examined empirically in two cases: cellular telephone services and yellow pages pub- lishing.

The local RBOC's rate for cellular telephone services in cities where RBOCs compete head- to-head was compared to the rate in cities where the local RBOC faces a non-RBOC competitor. Regression analysis was used to test whether rates were signi6cantly higher in markets where two RBOCs compete. The dependent variable was the home RBOC's local wireline rate (CYPRICE) in 125 metropolitan statistical areas (MSAs). The local wireline rates were regressed on a binary variable (BOC) which assumed the value of 1 if

488 WILLIAM F. SHUGHART I1

25.096

lmD%

H 15.096 a %! I-

i 5.096

0.096

-

-

-

: -

-

........................................................................................................................

.................................................................................................

...................................................................................

Figure 1. Individual RBOC shares of total cellular subscribers, 1988 and 1992. Source: EMCI 1993, p. 96 .

there was RBOC versus RBOC competition in variable definitions and data sources is provided the MSA, the population density of the MSA in Table 6.) (DENSZW), and the per capita income in the The population density variable was included to MSA (PCZNCOM.). (A complete listing of the control for variations in the cost of providing

Table 6. Variable Definitions: Cross-Section Analysis of Cellular Telephone Rates

Variable kenition and source

W R K E The real RBOC local wireline rate based on a 150-minute customer bill. Deflated by the relevant city or regional all-item CPI-U (Paul Kagan Associates, 1992 pp. 9-14)

DENSITY The MSA population density per square mile. Calculated from MSA population and land area figures. (US Bureau of the Census, PoprJarion of M e ~ p h Anac ond Componenf Geogmph: 1990 CPH-Ll45, data diskette)

PCINCOME The real per capita income in the MSA. Defhted by the relevant city or regional all-item CPI-U. (US Bureau of the Census, Income Swnmary Meanucs by Mebopoliran StatiaicalAnac, data diskette)

A binary variable which assumes the value of 1 if there was RBOC versus RBOC competition in the MSA, and 0 otherwise

BOC

THE EMERGENCE OF COMPETITION AMONG THE BABY BELLS 489

cellular telephone service across cities. It is ex- pected that the cost of providing cellular service will be higher in more densely populated areas because of the need for more cells in areas of intense cellular use. Per capita income was in- cluded in the regression to hold constant varia- tions in the demand for cellular service across cities, with the expectation that higher income areas will have a greater demand for cellular telephone services. The binary variable, BOC, was included to test for evidence of collusion in the cities where cellular service is offered by more than one RBOC. The estimated coefficient on this variable will be positive and significant if the RBOCs have cooperated in establishing the prices of cellular telephone services.

The results of the regression analysis shown below give no evidence of collusion in the setting of wireline rates (absolute values of t-statistics in parentheses):

WRICE = 40.85 + 0.003 DENSZW (1.97)

+ 0.002 PCZNCOME

- 9.017 BOC (2.44)*

(4.31)** R2 = 0.18, F = 8.996**, N = 125

(Asterisks denote significance at the 1% ?*) and 5% P) levels.)

In particular, the coefficient on BOC is nega- tive and significant at the 1% level, indicating that the local wireline rate is actually lower, not higher, in cities served by more than one RBOC.

The sign and significance of the remaining co- efficients are consistent with the predictions of economic theory. In particular, the coefficients on both population density (DENSITY) and per capita income (PCZNCOME) have the expected positive sign, suggesting that wireline rates for cellular telephone services are higher in more densely populated metropolitan areas and in ar- eas where incomes are higher.I3

In short, the empirical evidence weighs against any possibility of RBOC collusion in the case of cellular telephone services. Wireline rates tend to be lower in markets served by more than one RBOC and, when compared with the rates charged in markets served by only one RBOC, the difference is statistically significant. (Figure 2

compares the average wireline rates charged for cellular telephone services in the two types of markets.)

Cross-section regression analysis was also used to test for evidence of collusion in yellow pages publishing. Five different yellow pages listing rates charged by the home region RBOC in cities where it did compete against another RBOC were com- pared with those in which it did not. The five yellow pages listing rates examined where regular listings (RL), bold name and number listings (BLN), double half-column displays (DHC), dou- ble quarter-column displays (DQC), and quarter- column displays (QC). The rates were regressed on a binary variable (BOC) which assumed the value of 1 if there was RBOC versus RBOC competition in the city, city population (POP), and per capita income (PCZNCOME). (A com- plete list of the variable definitions and data sources is provided in Table 7.)

Both population and income were included in the regression to control for variations in the demand for advertising across cities. Both of these variables are proxies for the size of the market, and one would expect the demand for yellow pages advertising to be greater in larger markets. Cost variables were not included in the regression specification on the assumption that the cost of publishing yellow pages does not vary from city to city. Once again, BOC is included to test for evidence of collusion. If the RBOCs have cooper- ated in the setting of the rates charged for yellow pages advertising, the estimated coefficient on this binary variable will be positive and signifi- cant.

The results of the regression analysis reported in Table 8 are inconsistent with the collusion hypothesis. The estimated coefficient on BOC is not statistically different from zero in any of the specifications. BOC’s lack of statistical signifi- cance suggests that the rates charged for yellow pages listings are no higher in cities served by two or more RBOCs than in cities served by only one of them.

The sign and significance of the coefficients on the remaining variables are again generally con- sistent with the predictions of economic theory. The estimated coefficients on both population (POP) and per capita income (PCZNCOME) are positive in four out of the five regressions. And, except for per capita income in the bold name

490 WILLIAM F. SHUGHART Jl

$100

................................................................................................................................................................................................................................................................#� F @o .............................................................................................. L ’i 520 so

.....................................................................................

.................................................................. ...................................... ......................

Figure 2. RBOC mean real wireline price, RBOC non-wireline competitor versus other non-wireline competitors, 1992. (Source: Paul Kagan Associates 1992, pp. 9-14.)

Table

Variable

RL

BLN

DHC

QC

DQC

BOC

POP

PCIN- COME

7. Variable Definitions: Cross-Section Analysis of Yellow Page Advertising Rates

Definition and source

Real rate charged by the home region RBOC for a ‘regular’ yellow page listing. Deflated by the relevant city or regional all-item CPI-U. (YPPA, 1993a, pp. 389-559)

Real rate charged by the home region RBOC for a bold name and number listing. Deflated by the relevant city or regional all-item CPI-U. (YPPA, 1993a, pp. 389-559)

Real rate charged by the home region RBOC for a double half column listing. Deflated by the relevant city or regional all-item CPI-U. (YPPA, 1993a, pp. 576-745)

Real rate charged by the home region RBOC for a quartercolumn listing. Deflated by the relevant city or regional all-item CPI-U. (YPPA, 1993a, pp. 576-745)

Real rate charged by the home region RBOC for a double quarter-column listing. Deflated by the relevant city or regional all-item CPI-U. (YPPA, 1993a, pp. 576-745)

Binary variable that assumes the value of 1 if there was RBOC versus RBOC competition in the city, and 0 otherwise

The population of the MSA. (US Bureau of the Census, Population of MempolsOn Areas and Component Geogmphy: 1990 CPH-G145, data diskette)

The real per capita income in the MSA Deflated by the relevant city or regional all-item CPI-U. (US Bureau of the Census, Income Summuy Meanues @ Mehvpolitan Statisiical h a s , data diskette)

THE EMERGENCE OF COMPETITION AMONG THE BABY BELLS 491

Table 8. Regression Results: Yellow Pages Advertising Rates

RL BLN DHC OPC Constant 100.24 138.51 1970.85 1109.24

POP - 8.94E - 07 1.32E - 05 4.92E - 04 2.39E - 04 (0.25) (3.28)' (3.73)' (3.49)'

PCINCOME - 1.40E - 04 0.003 0.262 0.123 (0.04) (0.85) (1.99)C (1.80)E

BOC - 5.68 - 9.38 - 89.46 - 60.565 (0.46) (0.66) (0.19) (0.25)

R2 0.01 0.17 0.27 0.24

F 0.14 5.40a 9.87' 8.43'

N 65 85 86 86

ec 758.73

1.22E - 04 (2.99)'

0.051 (1.34)

2.227 (0.02)

0.18

5.77a

83 ~~ ~~

Notes: Absolute values of &statistics in parentheses. 'Significant at the 1% level. bSigniiicant at the 5% level. 'Significant at the 10% level.

and number listing (BLN) and quarter column (QC) listing regressions, the coefficients on both of the variables are sigdicant at the 10 percent level or better in these four cases.14

Acknowledgements The author wishes to thank Michael McDonald of Capital Economics for able research assistance. The usual caveat applies.

NOTES CONCLUSION

Regulatory and market changes since 1984 ensure that, if allowed to enter into manufacturing and interexchange markets, the RBOCs will not en- gage in the cross-subsidization or foreclosure that was feared at divestiture. Nor is there any reason to fear collusion among them. Descriptive and econometric evidence indicates that the RBOCs have competed with one another at every oppor- tunity since divestiture. The RBOCs' unwilling- ness or inability to collude in the past makes it unlikely that they will do so in the rapidly chang- ing technological environment of the future.

There is every reason to believe that the entry of the RBOCs into equipment manufacturing, interexchange service, and other adjacent markets will increase output and enhance the overall com- petitiveness of the telecommunications industry. I therefore strongly support the lifting of the line- of-business restrictions in the Modification of Fi- nal Judgment.

1. United States u. American Tel. & Tel. Co., 552 F. Supp. 131, 227-28 (DDC 19821, a f d sub nom. Maryland u. United States, 460 US 1001 (1983).

2. See id. at 190. 3. United States u. Western Elec. Co., 673 F. Supp. 525,

558 (DDC 1987), a f d in part and reu'd in part, 900 F.2d 283 (DC Cir.), cert. denied, 498 US 911 (1990).

4. Id. 5 . 15 USC 5 15. 6. 15 USC $8 1, 2. 7. See e.g., United States u. Pippen, 903 F.2d 1478,

8. See generally Shughart (1990, pp. 225-238). 9. 673 F. Supp. at 558. But see 900 F.2d at 296 ("IlIe

district judge's speculation that the BOG could impede competition by way of illegal (and perhaps criminal) collusion to divide markets among them according to territory would, in the absence of supporting evidence, seem to quallfy only as a theoretical possibility') (citation omitted).

10. For example, McChesney (1995) finds that GTE, an independent telco equivalent in sue to an individ- ual RBOC, was unable either to exclude or dis- criminate against rivals in the interexchange mar- ket or to successfully deter new entry.

1482-84 (11th Cir. 1990).

492 WILLIAM F. SHUGHART Il

11. The following RBOC-cable TV alliances were an- nounced in 1993: Bell Atlantic's attempted merger with Tele-Communications, Inc.; BellSouth's pur- chase of 22.5% of Prime Cable; " E x ' s an- nounced investment of $1.2 billion inViacom Inter- national; Pacific Telesis' option to acquire 75% of Prime Cable; Southwestern Bell's purchase of two cable systems in Virginia and Maryland from Hauser cable and its attempted joint venture with Cox Enterprises; and US West's purchase of a 25% stake in Time Warner Entertainment Co. See Broadcasting, 15 February 1993 at 3; Broodcarting & Cable, 24 May 1993 at 6; Wall Street Jownal, 5 October 1993 at A3; The (Montreal) Gazette, 30 October 1993 at D1; New York Times, 28 Novem- ber 1993 at section 3, p.1; Wall Street Journal, 7 December 1993 at A3.

12. Besides providing one more example of competi- tion among RBOCs, the RBOC-cable TV alliances are noteworthy because they further diminish the RBOCs' ability to collude. Such alliances speed the elimination of any 'bottleneck' at the local tele- phone exchange. Cable alliances give competing RBOCs the ability to provide local customers ac- cess to long-distance and on-line data services, bypassing the home RBOC's local exchange net- work. Bypass of the local exchange renders ob- solete the MFJ's basic premise that RBOCs could abuse their control over monopolistic local ex- change facilities.

13. Two other specifications of the regression equation were estimated. When the population of the MSA was included, the coefficient on BOC remained negative and significant. In addition, dummy vari- ables for each state were added to the specification as a way of controlling for differences in the local regulatory environment. While the estimated co- efficient on the BOC binary variable was positive in this case, it was not different from zero at standard levels of statistical significance. These re- sults are available on request.

14. These results are not sensitive to taking account of the actual number of competing yellow page direc- tories available in a given metropolitan area (OTHCOMP). When OTHCOMP was included in

any of the five regression specifications, the esti- mated coefficient on BOC was consistently insig- nificant. (The estimated coefficient on OTHCOMP was itself negative and insignificant in all live speci- fications.) Moreover, there is no statistically sig- nificant difference between the home RBOC's ad- vertisiig rates in cities where out-of-region RBOCs offer yellow pages and the rates charged by the home RBOC in other cities. This result is also not affected by the total number of competing yellow pages directories available in a particular geo- graphic market. This analysis provides further evi- dence that the RBOCs are competing rather than colluding in the yellow pages market.

REFERENCES

BIA Publications (1993). The 1993 Pa@g/PCS Direc- tory, Chantilly, VA BIA Publications, Inc.

Cellular Telecommunications Industry Association (1992). State of the Cellular Zndushy, Washington, DC.

Economic and Management Consultants International, Inc. (EMCI) (1993). The Cellulur Marketplace: 1993, Washington, DC.

Paul h g a n Associates, Inc. (1992). Cellular Rates 1992, March, Carmel, CA.

F. S. McChesney (1995). Empirical tests of the cross- subsidy and discriminatory access hypotheses in ver- tically integrated telephony. Managerial and Deciswn Economics, this issue.

W. F. Shughart I1 (1990). The Organization of Zndzuhy, Homewood, 11: Richard D. Irwin.

G. J. Stigler (1964). A theory of oligopoly. Jownal of Political Economy, 72, February, 44-61.

US Federal Communications Commission (1993). Mon- itoring Report, Staff of the Federal-State Joint Board, Washington, DC, May.

US Telephone Association (USTA) (1993). 1993 Phone Facts, Washington, DC.

Yellow Pages Publishers Association (YPPA) (1993a). Rates & Data Part I , , Vol. 1, October, Troy, MI.

Yellow Pages Publishers Association (YPPA) (1993b). Rates t Data Part 2, Vol. 2, October, Troy, MI.