In Response to Mark Cooper…

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Last December, I authored a blog entitled Price, Profit, and Efficiency: Mark Cooper’s Bungled Analysis.  Using basic economics, my blog describes in detail why a report authored by Mark Cooper from the Consumer Federation of America (“CFA”) entitled Comparing Apples to Apples:  How Competitive Provider Services Outpace the Baby Bell Duopoly Municipal Wireline and Non-Baby Bell Wireless Service Providers Deliver Products that are More Consumer-Friendly reached a conclusion that was not supported by economic theory.  Mark’s argument was that AT&T and Verizon charge higher prices and earn higher profits than do Sprint and T-Mobile and that such an outcome prescribes “a really good suspicion that [AT&T and Verizon are] using market power.”  My blog used principles-level economics to demonstrate that Mark’s argument was not correct.  The economics are simple:  if a firm offers higher quality, then the expectation is that it will have higher prices, higher profits, and higher output.  Since most people agree that Verizon and AT&T offer a higher quality service and better coverage, and the two companies are most favored by consumers as evidenced by their large relative market shares, this explanation of the data is very compelling.  Offering higher quality, and benefiting from it, is not an abuse of market power.  Mark’s argument was, therefore, economically invalid. 

Mark responded this week to my blog with a new paper with the lengthy title of Abuse of Market Power for Broadband Internet Access Service:  Blind Theory and Bonehead Analysis Can’t Hide The Problem — The Flawed and Misleading Analysis of the Phoenix Center and the Information Technology and Innovation Foundation (“Cooper Response”).  Mark does not contest the validity of my economic argument, calling it “theoretically plausible.”  (Id. at 9.)  Thus, my blog had its intended effect.  Nevertheless, because Mark took the time to read and critique my blog, and then CFA took the additional step to file his Response with at the FCC, I will offer my thoughts on his comments.

Unfortunately, the tone of Mark’s work is more emotional than thoughtful.  For example, he uses the term “bonehead” and describes my blog as an “effort to excuse the high prices and profits of the dominant wireless carriers.” (Cooper Response at 1.)  The truth is that my argument contained nothing more than principles-level economics lesson that was intended solely to point out that Mark’s economic analysis was wrong.  In that cause, I was successful.  

More discouraging is Mark’s defamatory statement that my blog was “fraudulent and intended to mislead policymakers.”  (Id. at p .9.)  Saying that someone’s analysis is wrong or sloppy is one thing (I’ve been accused and a few times guilty of both at one time or another), but filing a document at the FCC improperly accusing me (along with the Phoenix Center generally) of nefarious intentions is another.  Mark’s intemperate comments have no place in a policy debate, and they certainly do nothing to inform policy making. 

Putting aside Mark’s emotion-driven ad hominem and defamatory attacks, I did want to evaluate whether there was something substantive in his response to my blog.   I found nothing.

Let’s start with Mark’s contention that “Economics 101” teaches students that “oligopoly results in the abuse of market power to increase prices and profits.”  (Id.)  I’ve taught basic economics courses many times and neither Economics 101 nor advanced classes teach that oligopoly implies market power or the abuse of market power.  In fact, economics textbooks in principles courses do not even discuss oligopoly and perhaps never discuss the “abuse” of market power.  “Abuse of market power” is more an antitrust concept than an economic one, and would not normally be taught to students except in an advanced class like Industrial Organization or Antitrust Economics.  Also, Mark appears to be confusing the idea of having market power with the idea of abusing market power.  Abuse normally implies that a firm uses its dominant position to hurt the competitive process, yet all of Mark’s discussion relates to prices and profits, not anti-competitive actions.  High profits are not evidence of abuse, and not necessarily evidence of policy-relevant market power.  Given the fixed/sunk cost nature of supplying communications services, broadband service providers must have some degree of market power (i.e., a price in excess of marginal cost) but this need not imply high economic profits.  Such a markup is not an abuse of market power, but a necessity of the reality of market conditions.  Even a welfare-maximizing social planner would price communications services above marginal cost.

Moreover, when oligopoly is taught the professor tells his or her students that the outcome of oligopolistic competition runs the gamut from the perfectly competitive outcome to the monopoly outcome (under collusion).  As stated in Carlton and Perloff’s classic text, “[t]he equilibrium price in an oligopoly market lies between that of competition and monopoly.” (Modern Industrial Organization (2000) at 154.)  At one extreme is what economists refer to as Bertrand Competition, where firms choose price.  The outcome of such competition, if firms sell identical products, is the perfectly competitive outcome (price equals marginal cost) with only two firms.  Cournot Competition is the other popular flavor of oligopolistic rivalry, though in this form of competition firms choose quantity rather than price.  In Cournot Competition we get the familiar result of prices and profits falling as the number of firms increases.  Added to these are cartel models where firms act collusively to reduce output to monopoly levels, which is perhaps most akin to an “abuse” of market power (and a violation of Antitrust law).  Cournot Competition is, however, a non-cooperative equilibrium, so there is no “abuse” of market power.  In sum, as far as economic science goes, the outcome of concentrated markets can be anything from competition to monopoly, and the existence of market power does not imply its abuse.  Mark’s argument that principles students are taught that oligopolistic firms abuse market power is not correct. 

Mark finally turns to my rebuttal of his argument regarding prices, profits, and the abuse of market power.  He describes, incorrectly, my analysis as demonstrating that “the efficiency offered by [AT&T and Verizon] comes not from offering the same service as their competitors at lower cost, but from providing a higher quality service than their rivals for the same prices charged by the rest of the market, made possible by superior investment in their networks.” (Cooper Response at p. 2.)  Again, Mark is wrong and misunderstands the basic economics of the issue.  “Superior investment” plays no role in my economic argument.  My analysis took Mark’s assumptions of a higher price and higher profit and showed how these two outcomes, combined with a higher output, could be explained by a firm offering a higher quality.  All the economics required to prove Mark wrong was a simple supply-and-demand graph.  Indeed, higher quality could arise from many sources, not just investment.  In fact, the highest-quality firm could invest significantly less than its rivals, if, say, it possessed some secret formula or patent, or if quality was subject to scale economies.  While I mentioned the investments of firms in my original blog, it was an “also note” and immaterial to the fundamental error in Mark’s analysis.  I’ll discuss this more below.

Importantly, though Mark misstates the point of my blog, he does not challenge it.  He simply notes that “there are several other ways” one might interpret the same set of facts and describes my analysis as “theoretically plausible.”  As such, my work is done.  Mark offers a couple of alternative explanations for the price and profit data.  The two alternatives explanations Mark offers are, however, not helpful to his argument.  The first is to apply the dominant firm(s)/competitive fringe model.  In this model, there is one large provider (or a few in some models) and a large-numbers competitive fringe.  Dominance, in this model, typically is assumed to be the result of the higher relative efficiency or superior product of the dominant firm.  While the dominant firm earns higher profits, this profit is a rent to its relative efficiency, not an abuse of market power.  Dominance may arise from collusion, but there is no evidence of collusion in the mobile market that has led to the large market shares of AT&T and Verizon.  The two are simply winning in the marketplace.  Mark’s second alternative is a case where there is a “lack of competition for differentiated products, which allows dominant providers to abuse their market power.” (Cooper Response at p. 2.)  To an economist, this statement is pure gibberish —a meaningless string of key words in which the conclusion is assumed.  Neither of these alternatives is very compelling, and certainly not as compelling as the widely-accepted belief that AT&T and Verizon offer a higher-quality service and wider coverage than do their rivals, and the empirical fact that the two have higher market shares in an environment where their smaller rivals are willing to pay people to be a customer.

Finally, Mark points to my “huge mistake” regarding the capital expenditures of the mobile wireless providers, claiming that my argument “hinges on the claim that AT&T and Verizon have approximately twice as much in capital expenditures (CAPEX) as do the fringe firms.”  (Cooper Response at p. 2.)  As for the “hinges” claim, I offer you the sole statement I made about capital expenditures in my original blog:

Note also (from Table 1) that both AT&T and Verizon invest far more in their networks than do Sprint and T-Mobile, and this difference may explain the larger carriers’ superiority in the pursuit of customers.

That’s it.  My comment on CAPEX is of the “note also” and “may explain” variety, and completely immaterial to my demonstration as to why Mark’s economic argument was wrong.  It is true, and I am grateful to Mark for pointing it out, that the figures in my table for CAPEX were wrong.  But this was merely a typographical error that in no way weakens the power or applicability of my economic argument.  As now corrected and acknowledged in my blog, the actual investment numbers are AT&T ($8.25), Verizon ($7.06), Sprint ($3.89) and T-Mobile ($6.77), which demonstrate clearly that the larger providers invest more in their networks than those providers with smaller market shares (both in per-capita terms and in total, since their subscriber counts are multiplies of the smaller providers).  AT&T invests over 100% more than Sprint in per-capita terms, and about 20% more than T-Mobile.  While I admit to and apologize for the typo in my blog, my original analysis remains unchanged:  Mark’s argument that higher prices and higher profits lead to a “really good suspicion that [AT&T and Verizon are] using market power” is wrong. 

Mark does include some additional anecdotes demonstrating that AT&T and Verizon earn higher profits than do Sprint and T-Mobile.  This information adds nothing—the fact the two firms earn higher profits was an assumption I embraced when demonstrating Mark was wrong.  Notably, his additional information does, once again, confirm that AT&T and Verizon invest more than T-Mobile, and particularly Sprint, in their networks.  Mark also contends that differences among firms in “cash flow less capital expenditures” is evidence of an abuse of market power, but there is no economic theory that would support such a claim.  Superior efficiency would produce the same result.   Again, high profits are not evidence of the abuse of market power. Moreover, I have demonstrated before (here and here) that the accounting profits of the broadband providers—using the standard measures of accounting profitability—are meager relative to American industry.  That said, accounting profits can be a poor measure of economic profits, and it is the latter that matters for public policy and the assessment of market power.  Accounting profits are often used—in fact, I sometimes use them—but doing so requires recognition that the data are measuring, to a greater or lesser degree, the wrong thing.

At its core, I believe the debate between Mark Cooper and myself in this instance arises from Mark’s belief that higher market shares, higher profits, or higher cash flow are per se evidence of an abuse of market power and consumers.  This is simply not true.  Higher market shares, higher profits, and higher cash flow are a reward to firms that better serve the needs of consumers.  As Adam Smith stated, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”  Why do firms bother to improve quality?  Mark apparently wants them to do it out of the goodness of their heart, but this is not reality.  Quality improvements are motivated by a desire to increase market share and increase profits.  AT&T and Verizon do not have high market shares because they abuse customers; they have high market shares because they serve consumers better than their rivals do.  If they didn’t, then their customers would flee; they have options.

Finally, in a Perspective released this week titled Do Municipal Networks Offer More Attractive Service Offerings than Private Sector Providers? A Review and Expansion of the Evidence, I comment on the New America Foundation and Mark’s comparison of the prices of municipal providers and private providers, and also Mark’s multivariate analysis of the broadband pricing data.  My analysis of the pricing data is telling, and a closer look at the municipal pricing information offers some key insights into broadband pricing.  I encourage you to the read that Perspective.