The 1996 Telecommunications Act: An Anti-trust Perspective
Subcommittee on Antitrust, Business Rights and Competition
Committee on the Judiciary
September 17, 1997
Thank you, Chairman DeWine and Senator Kohl, for inviting me to testify here today on the subject of competition in telecommunications and video markets.
I am pleased that you have called this hearing for today, for as my tenure at the FCC draws to a close, it is altogether fitting and proper to examine the issues that I have focused much of my energies on as Chairman. The communications and information sectors of our economy are huge: accounting for one-seventh of the U.S. economy. For the past four years, and particularly since passage of the Telecommunications Act of 1996, we have been working to open up to competition those parts of those sectors that have regulated monopolies. We have also worked to open up the rest of the world to telecommunications competition. We succeeded in reaching the ground-breaking WTO Basic Telecom Agreement, will require sixty-nine countries around the world -- countries that account for over 95% of the global telecommunications market -- to embrace telecommunications competition.
I have thoroughly enjoyed working with the President, Vice President Gore, many members of Congress, my fellow Commissioners, Assistant Attorney General Klein and his predecessor Anne Bingaman, Assistant Secretary of Commerce Larry Irving, the communications industry, and FCC staff over these four years to lay the ground work for and then implement the historic Telecommunications Act of 1996 and to lead the rest of the world into the WTO Agreement. I believe that the Act and the WTO Agreement lay the groundwork for vibrant and competitive markets in all industry sectors across the world..
The preamble to the Conference Report set out the Telecom Act's goals most succinctly: to create "a pro-competitive, deregulatory national policy framework designed to accelerate rapidly private sector development of advanced telecommunications and information technologies to all Americans by opening all telecommunications markets to competition." We are on our way to creating such a framework. What remains to be seen is whether this framework can be implemented rapidly, as Congress foresaw, or will be done, if at all, only after years of delay and litigation.
Since passage of the Telecommunications Act, I have viewed the FCC's role as simple: to facilitate the competitive market structure that eliminates the need for economic regulation of communications. Through the rules we write and the decisions we make implementing the Telecom Act, we have acted affirmatively to open all telecommunications markets to competition. Through our review of mergers we will look carefully to determine whether the proposed merger will enhance competition, or whether it will slow the arrival of competitive markets and deregulation.
To achieve true deregulation, we must create competitive markets at all levels of the telecommunications industry. We cannot, for example, be satisfied just to create retail competition through resale. All parts of the networks must become competitive, from long distance to short-haul transport to switching to the distribution facilities (whether telephone, cable, terrestrial wireless or satellite) that reach our homes and offices. As parts of the network face true competition, the conditions will be in place for responsible deregulation of those segments. The Commission should be as aggressively deregulatory as it has been now in creating the structure for the underlying competition.
Obligations and Incentives
To act affirmatively to create a competitive market structure where none exists today, the Act employs two basic sets of tools which I will call "obligations" and "incentives." For obligations, the Act imposes a number of obligations on all telecommunications carriers, but particularly on all the incumbent telephone monopolies. Foremost among these are: the obligation to interconnect the monopoly network to the networks of other carriers and to exchange traffic with those networks with reciprocal compensation at no more than the additional cost of terminating that traffic; the obligation to lease segments or functions of the monopoly network to rivals as "unbundled network elements," to provide those segments or functions to rivals on a non-discriminatory basis, and to charge no more than cost including a reasonable profit for the lease of the elements; and the obligation to make all retail services available to rivals at a wholesale price of the retail price less costs that will be avoided by the incumbent monopolist.
In placing these three core obligations on incumbent telephone companies, Congress made a clear choice. It did not follow the British model of requiring all competitors to build fully redundant facilities. Congress recognized that such an approach would slow the development of competition because entrants would be required to carry substantial risk and make large sunk investments with few customers or assets to start. By giving entrants three different means to enter, entrants could begin with resale or by purchasing all the unbundled network elements, and could gradually substitute their own facilities for incumbent telephone company facilities as it became cost effective to do so and as they gained customers necessary to support such investments. Congress did not have to settle the age old debate about whether the local loop is a natural monopoly. Technology and the marketplace would be permitted to settle that dispute.
The great advantage of the 1996 Act's scheme for telecom competition is that competition can come to upstream markets without relying on whether the loop can be duplicated cost-effectively. We will likely see deregulation of transport and switching in some areas long before the loops in those areas are deregulated.
The 1996 Act did not just create obligations. The most notable incentives in the Act are contained in the Bell long distance entry provisions in Section 271. Those provisions most notably state that when Bell Companies can demonstrate that they have fully implemented the "competitive checklist" and can show that their entry is in the public interest, the Commission will approve entry into long distance. The Department of Justice has an important role. It must, and it has, provided its views on whether the checklist is met and whether entry is in the public interest. The Department of Justice's views receive substantial weight, but do not have a preclusive effect in the Commission's deliberations.
Section 271 is, of course, the Telecom Act's successor to the line of business restrictions contained in the Consent Decree that broke up AT&T in 1982. In my opinion, the strongest critique of the MFJ was that its "line of business restrictions" perpetuated the need for regulation by "walling off" a monopoly provider of local services. The MFJ also created vested interests in maintaining these walls. Section 271, in contrast, sets up process in which the FCC would use the incentive of long-distance entry to draw the BOCs into cooperating with local exchange competitors.
The Commission has, to date, carefully deliberated over each Section 271 application presented to it. In response to requests from industry and interested parties, the Commission has attempted, through its decisions, to cast light on what will constitute a successful application. The Commission's most recent decision was issued last month, when the Commission denied Ameritech's application for authority to provide long distance service in Michigan.
Some want to cast the debate over appropriate market opening rules and Bell long distance entry as a sort of Goliath v. Goliath, a grudge match to answer the question as to whether the local telephone companies or the long distance companies will come out on top. This view of what is at stake widely misses the point. Instead, it is important to remember that Section 271 is a deregulatory tool. It does not prohibit BOCs from doing anything -- it is a process that will permit them to do something that they have never before been allowed to do.
Local Telecommunications Competition and Innovation
The appropriate mix of these obligations and incentives is critical to the development of competition in the local exchange, a development that I view as absolutely necessary for our 21st century economy. History has shown that competition is not only the best way to get lower prices and better service, but is also the real key to innovation. Monopolies, no matter how benevolent and no matter how well regulated, do not produce the fastest cycles of innovation. Just look at the changes that have swept telephone equipment as a result of competition and deregulation of telephone equipment. You get better phones that do more, for less money, than you ever did when you had to rent your phone from Ma Bell.
Local competition is particularly important now because our local networks need to evolve to adapt to the country's growing data needs. Today, the local networks are generally "circuit switched." This is an inefficient way to have computers talk to computers. It may even, as the rise of Internet phone software may show, be an inefficient way to handle voice communications. At least for data, it makes sense to facilitate the deployment of "packet switched" networks -- using digital data packets, the basic language of computer communications. An Internet-friendly local network would offer the second line that you hook up to your computer as a packet network.
As long as local telephone networks remain a monopoly, and as long as competitors cannot get affordable access to local loops unbundled and configured in a data-friendly way -- such as by removing loading coils that interfere with ISDN and xDSL services -- local networks will innovate only as fast as the monopoly local telephone company chooses. Competitors also must be able to collocate appropriate equipment. Otherwise, the incumbent telephone company will remain the only game in town. Likewise, barriers to entry created by cable or telco control of wires inside the home or apartment building need to be brought down.
We cannot, of course, ignore the effects of unbundling rules on incentives for incumbent telephone companies to innovate. We should not handicap the incumbent just to advantage the rival. But there needs to be a level playing field for both, and incumbents that seek flexibility for innovation should also be able to show that they have opened their networks to allow others to innovate.
Industry Mergers and Consolidation
Part of creating a thoroughly competitive and thoroughly deregulated market structure is having a clear-headed and forward-looking view of mergers and other industry consolidations. Failure to pay attention to the longer-run effects of a potential merger can frustrate Congress' twin goals of competition and deregulation as surely as if the Commission and the states fail to make and enforce necessary pro-competition rules. The standards the FCC uses in the context of reviewing an industry merger stem from our duty and obligation to promote an industry structure that is conducive to competition and the public interest.
The role of the FCC in merger review has often been the subject of controversy and confusion. I would like to emphasize that merger review -- which is nothing more than FCC oversight of overall industry structure -- can facilitate the Telecom Act's goal of deregulation perhaps more than any other means. We all know that competitive markets operate much more efficiently and responsively to consumer demands than any regulated monopolist. If the FCC can facilitate an overall the market structure which is conducive to competitive market forces, then the sooner the FCC can deliver the other goal of the Telecom Act -- deregulation.
In addition to mergers, the FCC discharges this responsibility to promote a competitive market structure in other contexts. In determining eligibility for spectrum licenses, the Commission has at times precluded some entities from becoming licensees. For example, Local Multipoint Distribution Services licenses will be auctioned later this year. These licenses will be capable of being used to provide broadband voice, data and video in competition with both the incumbent telephone company and the incumbent cable company. The Commission barred in-region cable and telephone companies from becoming licensees, seeking to ensure that there will be yet a third potential, independent source for connection to the home, other than the telco and the cable company.
When you were considering the Telecommunications Act in 1996, you were told by all industry participants that they were itching at the chance to compete in one another's markets. And Congress rightly unleashed those forces in passing the Act. However, shortly after passage, we began to see a string of mergers unprecedented in this industry.
Mergers and other consolidations can be a potent competitive force. The synergies that result from combining assets may create from two small less efficient firms a large, more efficient one. The effect can be actually to deconcentrate the market, as the newly created and newly enabled merged firm wins market share from incumbent market leaders. However, mergers can also be defensive reactions against new competition, a way to establish a cove in the cozy harbor of monopoly power.
For these two very different reasons, industry mergers are a predictable response to the new opportunities created by the 1996 Telecom Act, the WTO Basic Telecom Agreement, and other procompetitive regulatory reforms.
However, it would be misleading to suggest that mergers divide into two neat categories of good and bad. A merger can have anticompetitive effects in one market, and procompetitive effects in another, and can have mixed effects that are difficult to disentangle in any single market. In view of these complexities, it is absolutely crucial for sound public interest policy that the Commission have an analytical framework to evaluating and balance the competitive effects of mergers or other consolidations. The framework should only balance the complex effects of mergers both now and in the future, anticipating the changes set in motion by recent deregulatory reforms.
The Bell Atlantic-NYNEX Order
In our order approving the Bell Atlantic-NYNEX merger, we set forward a public interest analysis in which a telecommunications industry merger will be approved by the Commission only if it can be shown to advance the goal of promoting competition. In my opinion, the Bell Atlantic-NYNEX decision is a landmark ruling -- in the order, the FCC describes in detail its flexible and dynamic public interest approach to industry structure.
The FCC considered the Bell Atlantic-NYNEX transaction under the Commission's public interest authority pursuant to Section 214 and Section 310(d) of the Communications Act. Those provisions place upon the applicant the burden of demonstrating that the proposed transaction is in the public interest. Although the Commission has authority pursuant to the Clayton Act to review a merger of common carriers and to determine whether such a merger violates Section 7 of the Clayton Act, we did not exercise that authority in the Bell Atlantic-NYNEX case. In evaluating whether applicants had met their burden of showing that the transaction was in the public interest, the Commission considered whether the transaction as a whole would enhance competition, balancing possible harms to competition against potential benefits.
Courts have ruled that the FCC's broad public interest directive is to be "so construed as to secure for the public the broad aims of the Communications Act."(1) In fulfilling this statutory obligation, the FCC examines how the proposed transaction will affect the development of competition in all telecommunications markets. As the expert agency charged with this responsibility, the FCC is required to consider the trends within and needs of the industry in this analysis. The public interest standard also requires the FCC to balance the potential pro-competitive effects of a transaction in certain markets against possible anticompetitive effects of the transaction in other markets.
In our analysis, the FCC found that the Bell Atlantic-NYNEX merger posed serious competitive concerns, generally arising out of our belief that Bell Atlantic chose to merge with rather than directly compete against NYNEX in the New York metropolitan area. Therefore, we approved the merger on the condition that Bell Atlantic agree to conditions that will help advance competition throughout the thirteen-state Bell Atlantic region. These conditions include provisions that will facilitate the creation of interconnection agreements between Bell Atlantic and competitive local carriers in the region. We also conditioned the merger on Bell Atlantic installing a properly-functioning operations support system that will permit competitive carriers to offer service to their new customers. We also ensured that smaller competitive carriers would be able to pay for collocation charges with installment payments. Although this final condition may not seem like much at first, it can have a critical short-term impact as to whether a start-up competitive carrier can enter and offer services even if it is currently strapped for cash, as most start-ups are.
A key element of the Bell Atlantic-NYNEX Order is the identification of a category of market participants called "precluded competitors." These are firms who have been effectively precluded from entering relevant markets by barriers to entry -- legal, regulatory, economic and operational -- whose dismantlement is intended by the Telecom Act.
For example, the BOCs are precluded competitors in the long distance market because they are legally unable to offer in-region long distance service until they obtain 271 approval. The long-distance carriers are precluded competitors in local markets until these markets are truly open to competition as required by the Telecom Act -- that is, until the LECs have systems in place that permit efficient resale and provisioning of UNEs that new entrants must rely on.
Given that the current distinction between local and long distance service is an artifact of the MFJ, most IXCs and LECs expect to compete to provided bundled local-long distance service in the future. In this nascent market for bundled service, we found that almost all current telecom firms are precluded competitors.
This flexible and forward-looking public interest analysis is particularly appropriate and necessary given the unique nature of telecommunications markets. Prior to the 1996 Act, telecom firms were generally precluded (for various regulatory, economic and operational reasons) from entering into other telecom markets. In other sectors of the economy -- where firms have generally been free to enter or exit as they choose -- it may be appropriate to presume that prior non-entry by the acquiring firm is strong evidence that entry is not likely to happen in the future. That is, the fact that Gillette may not currently make bleach -- even though it could -- is an important bit of evidence in a potential Gillette-Clorox merger. However, the same presumption would be inappropriate for telecom mergers, given that regulatory, economic and operational wals only recently are being torn down -- and even then the pace of the dismantling of those barriers is a significant question.
In order to discern the potential anticompetitive effects of a merger in the face of potentially declining entry barriers, the precluded competitor framework analyzes markets as they will when the 1996 Telecommunications Act is more fully implemented. We evaluated the relative incentives and capabilities of various market participants -- those actually in the market today and those precluded from the market -- to determine which had the strongest assets and capabilities to compete most effectively and soonest. Under this analysis we found that NYNEX, AT&T, Sprint, MCI and Bell Atlantic were all among the five most significant competitors in the New York local telephone market, and that the Bell Atlantic-NYNEX merger, therefore, should be viewed as a merger between two of the five most significant competitors in that market.
The combination of two of a small number of the most significant participants in any relevant market raises concerns under our public interest analysis. However, as I mentioned above, the public interest standard requires the Commission to balance this the anticompetitive effect against other pro-competitive effects that the transaction might entail in other markets. In this case, the Commission's approval of the Bell Atlantic-NYNEX merger was conditioned on procompetitive commitments of Bell Atlantic that apply in its entire thirteen-state region which mitigate and overshadow the possible adverse effects on competition in the New York metropolitan area. It was the broad effect of these pro-competitive conditions throughout the Bell Atlantic-NYNEX territory that weighed in the balance against the potential anticompetitive effects in the New York area local market.
Competition in Video Markets
Like local telecommunications markets, the marketplace for multichannel video programming is in a period of transition. We are moving from markets characterized largely by monopoly and restricted entry to a more dynamic and competitive environment. This trend is slower than many of us desire, but I believe it is irreversible.
In the marketplace for video programming, the Commission's 1996 Annual Competition Report to Congress on multichannel video programming distribution competition showed that while incumbent cable operators continue to be the dominate distributors of multichannel video programming, other video providers continue to increase their share of subscribers in many markets. Last year subscribership for non-cable distributors accounted for 11% of the total multichannel video programming subscribership. And the data show that non-cable subscribership has been increasing at an average annual rate of 22% since 1990. Preliminary analysis for our 1997 Competition Report indicates that these trends are continuing. For example, it appears that cable television industry's total market share declined to 87% over the past year.
However, even with the cable industry's decrease in its overall share of subscribers, the actual number of cable subscribers continued to increase in 1996. In fact, between our 1995 Competition Report and the 1996 Report, the number of cable subscribers increased by two million compared to the increase in combined subscribership for all multichannel video programming providers of 2.3 million. Again, Mr. Chairman, our preliminary research for the 1997 Report shows this trend continuing.
We also know that, as a result of acquisitions and trades, cable television operators continue to increase the extent to which their cable systems form regional clusters. The number of clusters of systems serving at least 100,000 subscribers increased approximately 40% in 1996, and these clusters now account for service to 50% of the nations's cable subscribers.
A number of significant developments in this area occurred in the cable television industry over the past 12 months and we will examine these developments in our 1997 Report. For example, some of the cable industry's largest MSOs have undertaken a number of system mergers, acquisitions, and exchanges in the last year which have created some of the largest system clusters in the country.
Our 1996 Report also found that vertical integration of national programming services between cable operators and programmers declined in 1996, primarily due to the sale of Viacom's cable systems. Of the 16 programming services launched in 1996, 10 are not vertically integrated.
In recent years, the Commission has put a number of rules on the books to promote the growth of competition in the multichannel video programming market and to give American consumers greater choices in video products and services. For example, the adoption and enforcement of our program access rules following the adoption of the 1992 Cable Act have been credited as an important factor in the development of both the direct broadcast satellite and wireless cable industries.
In addition, since the adoption of the 1996 Act, the Commission has adopted or proposed new rules to encourage increased competition. Our implementation of section 207 (Restrictions on Over-the-Air Reception Devices) of the 1996 Act has helped to encourage competition in the video markets by removing local barriers that restrict a consumer's ability to select an alternative video provider. The interest in our new rule has been phenomenal -- we have received more than 8000 inquiries from consumers and video programming providers concerning the rule. The Commission also recently proposed to establish new procedures for cable inside wiring which, if adopted, will provide access and certainty to alternative video programming providers, opening new choices for consumers. The Commission hopes to act on this proposal in the near future.
The Legal Fog
Despite the progress that the FCC has made in the past year to advance the cause of competition, there are, unfortunately, several threats that could significantly slow the pace of competition in the telecommunications industry. Most prevalent among these is the "legal fog" that surrounds every significant FCC decision immediately upon adoption. Sometimes I think that the second-most profitable job in Washington is to be a taxicab driver outside the FCC building on the date a major decision is released, because it seems that parties cannot wait to run down to the courthouse as soon as possible and file their appeals.
Congress should be concerned about this trend as well, because in passing the Telecom Act, you clearly wanted the nation's telecommunications policy to be decided by the market and responsible regulators -- not by a court administering a consent decree. What we have instead are thousands of devices of tortuous delay and tortured questioning of every phrase, word and punctuation mark of the Telecom Act.
I could point to several examples, but I only have time for one. For example, how can it be that Southwestern Bell just finds out that the Telecommunications Act is unconstitutional, as they have argued before a federal court in Wichita Falls? Did they not spend a considerable amount of time and money lobbying you in favor of passage of the Act?
Like the lawsuit of Jarndyce v. Jarndyce in Dickens' Bleak House, I fear that telecom litigation will drone on and on, long after I have left the Commission. It is a shame, because each year that local competition is delayed is a year of lost productivity for the American economy, a year of lost opportunity for entrepreneurs, and a year of lost choice for consumers. Congress can help fix these problems of endless delay by implementing a few reforms --
It has been a privilege to serve as Chairman of the FCC during these historic times, and my desire is to see competition flower throughout this industry as soon as possible. That would be a fitting reward for all the hard work the Congress, the President, the Commissioners, and the FCC staff have admirably undertaken during my tenure as Chairman.
Thank you for inviting me, and I will answer any questions you may have.
1. Western Union Division, Commercial Telegrapher's Union, A.F.of L. v. United States, 87 F. Supp. 324, 335 (D.D.C. 1949), aff'd, 338 U.S. 864 (1949). See also, Washington Utilities and Transportation Comm'n. v. FCC, 513 F.2d 1142, 1147 (9th Cir. 1975); FCC v. RCA Communications, Inc., 346 U.S. 86, 93-95 (1953).