It’s been over eighty years since the Communications Act of 1934 created the Federal Communications Commission (“FCC”) for the purpose of overseeing the nation’s communications industries.  Still, as revealed most recently in the Commission’s Tariff Investigation Order and Further Notice of Proposed Rulemaking on Special Access Services (hereinafter “BDS Further Notice”) the Agency has no idea how to define or measure market power in telecommunications markets.  In fact, its BDS Further Notice offers no apparent definition of market power, which is a significant deficiency for a regulatory regime allegedly based on the presence of market power.

There are some hints about how the Commission is thinking, however.

At one point in the document, the Agency mistakenly uses the definition of “monopoly power” (ft. 479), but as it is well-known “monopoly power” is not the same as “market power.”  It’s perhaps a harmless mistake, since this definition of monopoly power appears to play no role in the Commission’s analysis.

The Commission provides a bit more clarity in BDS Further Notice by citing to Professor Marc Rysman’s White Paper (Appendix B of the BDS Further Notice) as “direct evidence of market power in the supply of various services (at ft. 543).”  Since the Rysman Paper is nothing more than an attempt to compare prices in monopoly and competitive markets, it’s reasonable to assume that such a comparison is the basis for the Commission’s definition of market power.  That is, to the Commission, market power implies something along the lines of the ability to charge a price above the competitive level.

Here’s the problem—the Rysman White Paper says nothing about market power.

For those that wish to have a firm grasp of the problem, I’ll direct you to my earlier Bulletin on the Phoenix Forbearance Order (The Impossible Dream:  Forbearance After the Phoenix Order) and my recent Perspective on the FCC’s Special Access data (The Road to Nowhere: Regulatory Implications of the FCC’s Special Access Data Request).  It appears that my earlier analyses were too complex for the Commission’s leadership, so let me bring it down a few notches for the expert agency’s consumption.

Say you’ve got two markets, A and B in which a service is sold.  Providing the service requires fixed costs but marginal costs are zero.  Firms will enter the market as long as they can make profits from doing so.

Market A is served by a monopolist and the price is $100.  The $100 price produces revenues just large enough for the firm to breakeven.  There is no excess profit and, thus, no market power. That is, any price less than $100, the monopoly price, would result in no service being provided at all.  Since the monopolist breaks even, there is no incentive for another firm to enter.

Market B, alternately, has lower fixed costs and is thus served by a duopoly.  Due to competition the market price is $70.  Again, let’s say revenues are just high enough to cover fixed costs and, therefore, to break even.  There is no excess profit and, thus, no market power.  There is no reason for a third firm to enter.

If we compare the prices between Markets A and B, we see that the “competitive” price is 30% lower than the monopoly price.  This comparison is the essence of the Rysman White Paper (though his estimates of the price differential are relatively puny).  Yet, by definition, market power is absent in both markets.  Obviously, though competition reduces prices, finding a price difference between monopoly and duopoly tells us nothing about market power.  The reason this method fails is the presence of, and the failure of Rysman and the FCC to consider the importance of, fixed costs and their role in determining market structure.

The Commission’s leadership hasn’t always been so ignorant about the economics of telecommunications.  For instance, former Chairman Reed Hundt (who employed and, more importantly, often listened to very good Chief Economists) observed,

In an industry with large sunk costs and small marginal costs, like most of the telecommunications industry, pricing that goes to marginal cost will not provide an adequate return to the investors who provide capital. Investors will be cautious about investing money upfront because ex post competition could drive prices to nonremunerative levels.

How true, and how nice it would be, if such apparent facts were incorporated into the current Commission’s analysis.  But, I wouldn’t hold my breath.  The last Chief Economist of the Agency (who has not been replaced) described the current Commission as an “economics-free zone,” and there’s plenty of evidence to support that assessment.

Importantly, econometric analysis attempting to account for differences between markets A and B (as done by Rysman) offers no solution.  A really good econometric model of prices, even if using very good data on demand and costs, will not make this $30 false indicator of market power go away.   In fact, the better the econometric model and the better the data, the closer to a $30 differential the econometric model will produce.  But, as shown plainly above, the $30 difference tells us nothing about market power.  Zero profits are earned in both markets A and B—there is no market power.

It should now be clear that, standing alone, the Rysman White Paper (along with a similar analysis contained in the Declaration of former FCC Chief Economist Jonathon Baker filed on behalf of parties wanting special access services regulated), tells us nothing about market power.  And, since these analyses appear to be how the Commission is thinking about market power, the Commission BDS Further Notice has failed to provide any meaningful definition, and thus cannot provide any meaningful evidence, of market power.