Late Wednesday night, the Federal Communications Commission released a Report and Order that would suspend, on an “interim” basis, its rules for automatic grants of pricing flexibility for special access services “in light of significant evidence” that the current deregulatory trigger—i.e., two competitors have collocated in a single Metropolitan Statistical Area (“MSA”)—is “not working as predicted.”  In particular, the Commission found that the geographic territories contained in most MSAs are “overly broad” and, in contrast, most competitive entry is occurring only in areas with “extremely concentrated demand.”  Although the Commission concedes that it “currently lack[s] the necessary data to identify a permanent replacement approach to measure the presence of competition for special access services”, the agency promised both (a) to issue a comprehensive data collection order within sixty days once OMB signs-off; and (b) to “undertake a robust market analysis to assist us in determining how best to assess the presence of actual and potential competition for special access services that is sufficient to discipline prices.”

While this Report and Order will certainly provide fertile ground for new research over the coming months, I do have three initial observations I’d like to share.

First, as we have argued in both our published academic work and in various blogs, there is a clear need for better analysis of high capacity services, starting with better data collection.  Apparently, as noted above, the Commission agrees.  Yet, as Commissioners McDowell and Pai, along with Congressmen Upton and Walden, all astutely point out, if the Commission concedes it needs more data, then it is hardly wise to radically change policy without an adequate record.  Indeed, for FCC Chairman Genachowski—who, as we all know, regularly likes to proclaim that he wants “to run a process that is fact-based and data-driven”—to bring the deregulation of legacy TDM services to a screeching halt without first doing his homework is just not good government.  Instead, just like the Section 706 Order the FCC released this week, the Special Access Report and Order again reeks of regulatory activism with a deliberate ignorance of the facts.

Second, I think the Commission (ironically egged on by the industry and various free market advocates), uses the wrong analytical framework to ask the wrong policy question in the Report and Order.  That is, everybody keeps focusing on using a traditional antitrust “market analysis” (i.e., head counts) to measure the level of competition as a bellwether of whether or not the FCC should grant pricing flexibility.  However, given the basic economics of the industry (i.e., high sunk costs and few firms) and the heretofore inability to gather adequate data from unregulated competitors to the ILECs, I fear we are going to be arguing over the level of what constitutes adequate competition until the cows come home.  (If anything, we have shown that the current Commission has often used an antitrust-type analysis as a pretense for more regulation of spectrum and other TDM architecture.)  Instead, as we pointed out in our 2009 paper entitled Market Definition and the Economic Effects of Special Access Price Regulation, the correct policy question to ask is simple and straight forward: do the costs of price regulation of high capacity circuits outweigh the benefits?  As we show in our paper, the answer is clearly “yes.”  Given the nature of the market for Special Access services (i.e., bilateral monopoly), there are no benefits to regulation. 

To illustrate this point, we demonstrated that if geographic markets are “location specific” and supplied by a monopolist as the proponents of regulation claim, then price regulation of high capacity circuits reduces economic welfare in all instances.  Stated another way, even with monopoly supply, regulation offers no improvement in economic welfare, meaning the debates over the extent of competition and profit margins in such markets are irrelevant.  As we showed, the effect of regulation is mostly to transfer profits from sellers to buyers, so the special access debate appears to be largely a “quibble over rents.”  Indeed, every $1 of transfer costs more than $1 to society, so price regulation of high capacity circuits unambiguously reduces welfare.  Our analysis therefore demonstrates that the present case for regulating high capacity services is woefully inadequate and poorly conceived.

Which brings me to my final observation:  While the Commission decided to suspend pricing flexibility because it could not find sufficient evidence that there is sufficient “actual and potential competition for special access services” that can “discipline prices”, nowhere in the Report and Order does the Commission provide any specific data that current unregulated prices do not fall into the proverbial “zone of reasonableness.”  Instead, the Commission simply relies on anecdotal statements from special access purchasers like Sprint who argue that unregulated “high special access prices hinder their ability to hire employees, invest in their networks, and conduct research and development.”  Yet, without concrete evidence that prices are “too high,” it is unclear what the agency means by asserting that the pricing flexibility process is “not working as predicted.”

Given the current FCC’s penchant for regulating before they do their homework, let me posit a simple hypothetical question:  What if it turns out that regulated special access rates are actually “too low”?  Over the past few years, we have seen the household and small business subscription rate to the ILEC networks fall from over 90% to less than half (less than 40% in some cases).  Much of the telephone network’s costs are joint and common, and recovery of those costs is shared across the full range of services the network provides.  As the contribution margin from residential phone service falls, then other services on the network, including Special Access services, must bare an ever-increasing share of the joint and common costs.  As such, a full-scale rate proceeding may indicate that regulated prices, which were established ages ago under regulated monopoly conditions, may very well be “too low” in the current environment.

Perhaps, then, it is not a review of the agency’s deregulatory approach we need, but rather a review of the FCC’s regulatory approach to high capacity circuits itself.