[ Text Version ]


JUNE 19, 1997

(as prepared for delivery)

Thinking About Why Some Communications Mergers are Unthinkable


We are at a watershed point in the evolution of the telecommunications industry. Whether we have competitive or monopolized markets depends on the interactive and complex decisions of private firms, investors, Congress, agencies and courts. At stake is the possibility of billions of dollars of economic growth and astounding feats of innovation only achievable through competition.

This fateful period of communications history began just over one year ago when Congress passed the landmark Telecommunications Act. After long debate, Congress courageously opened communications markets to competitors that had been precluded by law or by the absence of procompetitive rules. Since then, the FCC has issued a trilogy of implementing orders that comprise several dozen pages of rules necessary to allow new entrants to share or connect to the existing network of the local telephone companies.

Incumbents are now seeking to stay these rules across the board and to reverse Congressional, FCC and state commission decisions in courts and state legislatures. Nevertheless, we're on the eve of competition. Companies stand poised to enter new markets and to defend vigorously their existing markets. This is, I believe, exactly what Congress intended -- for new entrants to be invited and even obliged by new circumstances to enter markets from which they have been previously precluded: ixcs vs. lecs, and vice versa; telcos vs. cable and vice versa.

If by government policy and private zeal we get competition going, the winners will be taxpayers who enjoy the benefits of economic growth, job seekers who have new opportunities for work, entrepreneurs who have new markets in which to make their visions come to reality, financiers who have new ventures to back, consumers who have new choices, and even incumbents who have the chance to be competitors in markets from which they were previously precluded. The ultimate reward will be deregulation of the whole communications sector when competition is real.

It is natural in this time of transition from the monopoly paradigm to the competitive regime for firms to explore the possibility of entry into new markets by way of merger. It is natural for firms to ask lawyers what is thinkable and what is unthinkable in the way of such mergers. And it is unsurprising, if unprecedented, for AT&T to assert publicly that the hypothetical of an AT&T-Bell merger is "not unthinkable." That happened last week.

It is right and proper for government to respond to such assertions by trying to give clear guidance to firms about what mergers are unthinkable and what are thinkable in the new world of open communications markets. It is right and proper for AT&T to invite us to a dialog on the subject of whether a hypothetical AT&T-RBOC merger is unthinkable. And so today I will discuss hypothetically that which AT&T has hypothetically discussed in recent days. For the reasons set forth here my belief is that a combination of AT&T and an RBOC is unthinkable.

Under the statutory authority granted to FCC in sections 214 and 310 of the Communications Act, as well as under the Commission's authority to enforce Section 7 of the Clayton Act with respect to combinations of common carriers, the FCC would eventually be obliged to pass judgment upon any such merger.

If the FCC is presented in the future with the sort of merger that AT&T is publicly discussing as a "hypothetical," we will judge it on the law and the specific facts that are placed on the record at that time.

However, it is bad policy and bad practical application of the 1996 Telecom Act for government to act in response to a virtual request for hypothetical discussion from AT&T in the way the Delphic Oracle treated supplicants for guidance. Cryptic, virtually indecipherable utterances from government do not give guidance to lawyers and firms and investors who deserve, indeed require, every opportunity to plan ahead with certainty about the rules that are intended to guide the transition from monopoly to competition.

If certain forms of cooperation are going to be out of bounds for some firms in some markets, we need those firms to devote their zealous energy and precious resources to the push for fair, pro-competitive rules and real entry in all telecommunications markets, rather than to be encouraged to spend their time trying to accomplish an unthinkable combination. No one benefits from protracted uncertainty that freezes business zeal into a state of suspended animation, while government authorities mull proposed combinations.

Furthermore, Congress deserves to know that its laws and policies will be enforced, rather than frustrated by years of debate in court about corporate combinations inconsistent with those laws and policies. The Telecommunications Act of 1996 was intended to repeal the MFJ, not replace it with tortured litigation of consent decrees in various jurisdictions. Consequently, the agencies and the courts charged with implementing Congress's directives must be vigilant in safeguarding these principles against all potential threats.

Of course it is impossible to discuss every conceivable hypothetical merger today. But some discussion can be offered about the hypothetical AT&T-RBOC merger presented by AT&T's CEO. I hope to do so today, in a spirit of open-minded willingness to have a discussion about matters of terrific importance to the future of the American economy.

It's been reported that some believe a merger between two adjacent Bell companies should be evaluated as a "horizontal" merger whereas an AT&T-RBOC merger would be "vertical." Horizontal mergers typically involve combinations of firms that operate at the same "level" in an industry; in other words, they sell the same or similar products to the same customers. By contrast, a vertical merger typically involves two firms at different levels in a distribution chain. From an antitrust perspective, horizontal combinations are often viewed with greater skepticism than vertical combinations.

Because the Bell Atlantic-NYNEX merger is currently before the FCC, I cannot and will not comment on that merger or how I think it should be categorized. Nothing in this speech should be read as any kind of communication on the topic of that merger.

However, AT&T is currently present in the same geographic markets as each and every RBOC. In each RBOC region, the Bell and AT&T offer service to the same customers. They have parallel and not wholly dissimilar facilities. They often have parallel billing systems. They have brand name recognition and marketing capability with respect to the same customers. They are what ought to be called "precluded competitors" -- that is, firms that naturally would compete with each other, and that have not competed only because they have been precluded from doing so by law and by the absence of enforceable procompetitive rules. In fact, these particular precluded competitors have sought the legal rights and legal capabilities to compete with each other. Analysis of any hypothetical AT&T-RBOC merger as a horizontal merger is therefore not ill-advised.

This brings us to a discussion of something that we've been thinking hard about at the FCC: how to evaluate combinations of precluded competitors in the rapidly changing telecommunications industry.

You might say that providing local exchange service is like being a bran merchant and offering long distance is like being a vendor of raisins. The goal of the Telecom Act was to get the raisin merchants into the bran business, the bran sellers into the raisin business and everyone into the raisin bran business -- that is, bundled telecom services.

Of course, telecommunications may be more susceptible to technological innovation than the cereal market. But the presence of technological change and innovation does not mean that proposed combinations of precluded competitors are now "thinkable." It is not necessarily the case that new technology can quickly cure the cold that telecom markets would catch from allowing or even opening the door to allowing ill-advised combinations. And that cold can kill the patient -- the telecom sector -- which is after all a monopolized market only just started on the road to recovery.

When we evaluate mergers in communications markets, we need to determine whether the parties in question fall into the category of competitors that have been precluded from entering a market. It may aid clarity of thought to call firms precluded competitors instead of potential competitors when law, or the lack of pro-competitive rules, not inclination or capability, is the reason they have not yet become actual competitors. In any event, under potential competition theory and under our newly named "precluded competition" theory, the result is essentially the same: an AT&T-RBOC merger is not thinkable.

Nor can would-be merger partners reasonably suggest that certain conditions support a hypothetical merger, when those same firms helped generate those conditions by not taking all appropriate actions consistent with the basic tenets of the Telecom Act. Rather, sound analysis of hypothetical mergers looks at the opportunities for competition created by effective enforcement of the new law and new rules at the federal and state level. Government cannot be asked to condone mergers on the grounds that government cannot or will not write and enforce fair pro-competition rules.

Now let's look in a little more detail at the competitive issues raised in an RBOC region by a hypothetical AT&T-RBOC merger.

In the long distance market in the subject RBOC's region, AT&T's share of the residential market is presumably about 70% and its share of the business market is presumably about 40%, measured in minutes or revenues.

An RBOC can enter the long distance market in its region when it chooses to take the steps necessary to meet the section 271 checklist and the public interest standard under the Telecom Act. If an RBOC has the will to take these steps, there is a way to enter the long distance market. An RBOC is a precluded competitor in long distance, but it has in its own hands the capability to lift the terms of preclusion.

The impact of RBOC entry, when it occurs, can be judged by examining the experience of Southern New England Telephone in long distance. This experience and other evidence suggests that one could reasonably expect that the in-region RBOC will garner in a fairly short period of time roughly 20-30% of the long distance market when it chooses to do what is necessary in order to enter that market. The reason for this impact is the network, customer information, brand recognition, and other assets and capabilities that an in-region RBOC brings to bear as a long distance competitor.

Combining the long distance market share of AT&T in any RBOC region (even as it may be reduced by RBOC entry) with the long distance market share that reasonably can be imputed to the RBOC yields a resulting concentration that is unthinkable.

The analysis of an AT&T-RBOC hypothetical merger in terms of the local market is similar. Every RBOC is, in its region, by far the dominant firm in the provision of in-region local exchange service. Only a tiny fraction of customers choose any other local service provider.

According to its own assertions and the convictions of most in the business community, one of the best positioned entrants in the local exchange market is AT&T. It is the largest telecommunications company in the country. It already has a business relationship with presumably about half the customers in any given Bell region. It has extensive network assets, a powerful brand, customer information, and sales force expertise. AT&T has already publicly set the goal of taking one-third market share in Bell markets.

Indeed, it's difficult to imagine that any other firm will be a more effective broad-based local entrant than AT&T as long as the market-opening provisions of the Telecom Act are fully implemented and enforced. It seems unreasonable to assert that AT&T cannot obtain at least some meaningful entry in Bell markets if it seeks to enforce all the rights of entry given to it under the new law and our rules.

Imputing to AT&T even a modest percentage of market share taken from the existing Bell incumbent in that Bell's region, as we must do under our potential or precluded competitor doctrine, then under conventional and serviceable antitrust analysis, a merger between it and the Bell incumbent is unthinkable. It would be exactly the type of horizontal combination that antitrust law frowns upon.

Suppose we ponder the telecom market of the future and assume that many customers will prefer buying telephony services as integrated local-long distance bundles: in other words, let's assume raisins and bran are combined for sale as raisin bran to many or most customers.

One way to think about a bundled market is to ask how much of all telecommunications revenue in a Bell region goes to that Bell and how much to AT&T. Including access, a typical Bell earns about 60% of all telecom dollars in a given state, while AT&T, excluding access payments, gets about 20%. Assuming these market shares, a combination between the two in the bundled market is unthinkable.

Nor are the concerns created by an AT&T-RBOC merger necessarily confined to in-region combinations. Many of the RBOCs have expressed intentions to compete out-of-region in long distance and, eventually, local markets. They could be formidable competitors of AT&T, among others, in all out-of-region markets. This would be particularly true if the RBOCs supported and used the pro-competitive rules written by the FCC.

AT&T has expounded the idea that any merger between it (or any IXC) and an RBOC must pass the test of being good for competition. To quote from a recent speech by AT&T's Chairman:

"But most important of all, any partnership between any long distance company and any regional Bell company would have to be pro-competitive.... No exceptions."

A hypothetical combination between an RBOC and AT&T out-of-region does not appear to pass this test.

Moreover, there could be risky "spillover" effects of such an out-of-region combination. Could the RBOC and AT&T management teams reasonably be expected to collaborate and share their best-developed business secrets and strategies out of the RBOC region even while using those same tactics and strategies against each other in the RBOC region? Could the RBOC join AT&T in pressing for its legal rights as an entrant out-of-region to be upheld at the FCC or in court, while arguing in the same forums against AT&T when the dispute concerned an in-region issue?

To implement a competitive entry strategy in today's transition period, a new entrant has to be an aggressive, albeit reasonable, advocate in all venues -- in the marketplace, in negotiations, in state regulatory proceedings, in front of the FCC, and in court. The entrant may not be always right and it may not always win, but its shareholders will expect it to be always aggressive.

Some have discussed the benefits to competition from dividing an RBOC into separate wholesale and retail operations, akin to the Rochester Telephone plan and a recent SNET proposal. Separation of an incumbent company into wholesale and retail operations may or may not be a necessary pro-competitive step. If it is necessary or useful, AT&T or anyone else can so assert. But such a wholesale-retail separation does not mitigate the potential harm to competition created by a hypothetical Bell-AT&T combination that still eliminates a competitor from relevant markets.

Contemplating, discussing, negotiating and proposing unthinkable mergers can have negative impacts on competition. During the period of negotiation and subsequent regulatory scrutiny and likely court challenge, local competition plans and actions can be seriously slowed down. Worse, other unthinkable merger ideas might be pursued in reaction to an AT&T-RBOC merger announcement. These are additional reasons to discuss now what hypotheticals are correctly regarded as unthinkable.

Meanwhile, new entrants need to be pushing for fair interconnection agreements. This requires negotiation where necessary and reasonable pursuit of rights and remedies. New entrants need to be pushing for fast, fair and efficient ordering and provisioning so they can aggressively sign up customers. New entrants need to be planning and making the requisite investments so they can provide the competitive access to the information network to all parties in the economy.

Recently, LCI International, one of the larger long distance companies, presented us with a detailed petition to set performance standards for operational support systems. We have responded rapidly to this petition by asking comment on an expedited time schedule so that our process will not frustrate efficient competition. We will act rapidly and fairly in response to petitions of incumbents and new entrants. We will always make our decisions objectively and as rapidly as possible.

Teddy Roosevelt wrote, "The true function of the state ....should be to make the chances of competition more even, not to abolish them." Hence Roosevelt was a trustbuster. He felt that the trusts -- what we call monopolies and what gave rise to the phrase 'antitrust' -- were the enemies of the three values he enunciated in his 1905 inaugural address: "Energy, self-reliance, and individual initiative."

As David Brooks has explained in his essay on Roosevelt in the Weekly Standard, June 23, 1997, Roosevelt's philosophy resonates in our time. Similarly, antitrust policy, as we move to the 21st century, can reflect, if not the economic theories, at least the values of antitrust policy developed as the country moved into the 20th century.

Of course, the factual inquiries and the analytical tools of modern antitrust are very different than they were in Roosevelt's time. But the need to have open, honest discussion of what's best for the economy is as great now as it was then. I appreciate the opportunity to talk with you about hypotheticals that are and ought to be unthinkable, because they do not serve the values or goals of our historic, present, and future economic policies.

Thank you.