Washington, DC (November 11, 2009) – Emphasizing its agreement that the FCC “…must be guided by evidence, not rhetoric,” the American Consumer Institute today released a point-by-point report refuting the claims about investment and regulation made by Free Press. Given the close relationship between broadband network investment and consumer welfare, ACI found the Free Press contentions particularly hostile to current and potential network subscribers and misleading as a basis for emerging national broadband policy. In its critique — “The Informed Policy Maker’s Guide to Regulatory Impacts on Broadband Network Investment” — ACI called attention to fundamental errors by Free Press in logic, facts, financial accounting practice and long standing principles of real investment. ACI’s report concluded:

• A basic principle of finance is that regulatory risk will tend to reduce investment;
• It is nonsense to claim, as Free Press does, that network providers are “disinvesting” or that they “boost profits” by reducing investment; and
• Returns on investment in applications and services are directly and critically dependent on the growth and quality of networks.

ACI Fellow Larry Darby noted: “I can find no basis in history, financial principles, commonsense, or in the Free Press’ paper for concluding that proposed net neutrality regulations will have no impact on broadband network investment.” A copy of the report is available here — fp-report1

How “Cozy” is the BB Duopoly?

PFF Congressional Seminar:

“Broadband Competition: Is the Glass Half Empty or Half Full?

Delivered on June 12, 2009

**************************************************

Thank you.

· I want summarize some results of our ongoing work, from a consumer welfare perspective, What kinds of tests for market failure should suffice to warrant imposition of common carrier regulation in this sector?.

· The late senator Daniel Moynihan observed that folks are entitled to their own opinions, but not their own facts. So it is in the debate over private and public sector roles in the National Broadband Policy.

· In the next few minutes I will add some facts to some widely expressed opinions on one issue in that debate: the importance of (duopoly) market structure in the provision of broadband services.

First some opinions:

Opinion Number One. The FCC has allowed a cozy duopoly of telephone and cable companies to dominate the broadband access market…The reliance on this cozy duopoly has been disastrous for the United States…Consumers pay too much for too little.” (CFA)

Two. [Broadband] Prices are well above cost-plus reasonable profit; investment is withheld until absolutely needed; innovation is actively discouraged; and consumer welfare suffers. (CFA, CU)

Three. “…when a market has fewer than the equivalent of six equal-sized competitors, the market just doesn’t function properly. The FCC has ignored the mountains of evidence that our broadband markets are concentrated, anti-competitive, and fundamentally broken. (Free Press)

No matter how you interpret these opinions they say: “Nevermind what kinds of market conduct we observe or performance we can measure, the problem is in the structure; the duopoly; the cozy duopoly. (I looked up cozy to make sure I did not mischaracterize the suggestion. My Thesaurus suggests warmth and ease, contentment and comfort, family like intimacy, close association, discreet and cautious attitudes, connivance.)

These are opinions. But we obliged to ask: “Where’s the Beef?” What are the facts.

No reasonable, objective, well informed observer would suggest any form of collusion between cable and telco BB providers (every indication is that they are aggressive rivals in the voice market, in the data market and in the TV market marketplace and on many policy issues such as franchising and access to programming); or that there is no innovation in the sector (switching, transmission, digitization, bandwidth expansion) ; or that firms are “rationing” capacity (Wall Street suggests the contrary); or restricting supply in order to fetch higher prices (firms expanding output in response to demand) ; or to discriminate in ways to create market power; or that there is excessive profit in the sector (I will return to that in a moment).

The economic case for common carrier regulation is sometimes refers to two events of market conduct (Madison River service denial and Comcast traffic management); or international differences, but proponents’ case for regulation ultimately turns on market structure – duopoly. In fact, the principal corporate force behind the call for common carrier regulation explicitly stated as much:

The broadband problem….. “is the market itself, rather than in a roster of actual and potential “bad acts.” In other words, the flaw is structural, not behavioral.”” (Google)

With that in mind let me review with you quickly from six different perspectives some facts about duopoly and its threat, without regard to conduct or performance, to economic welfare. These views are 1) the neoclassical industrial organization view, 2) views from game theorists, 3) Outcomes from experimental economics, 4) evidence from other sectors served by two dominant firms, 5) what competition policymakers have to say and 6) some evidence of performance of the BB duopoly. These contrast sharply from the views expressed in law journals and Net Neutrality advocates.

1. Neo Classical Industrial Organization View. A fair assessment of scholarly work on the topic suggests no support for equating duopoly with market failure. The author of one well know textbook concluded his review as follows: “Economists have developed literally dozens of oligopoly pricing theories – some simple, some marvels of mathematical complexity. This proliferation of theories is mirrored by an equally rich array of behavioral patterns actually observed…Casual observation suggests that virtually anything can happen….” Indeed the only conclusion from oligopoly theory is that it is inconclusive.

On the Structure-Conduct-Performance framework more generally, it is well established that it may be a useful way to organize and describe our research, but that there are no reliable cause and effect relationships observable. In short, structure does not predict either conduct or performance and cannot alone provide a basis for government action.

2. Game Theory “ The reviewer for the IO survey concluded: Having warned the reader at the outset that there are many theories of oligopoly, I am left with the task of identifying the lessons learned from the collection of models discussed above…What we are in need of most now are further tests of the empirical validity of these various theories of strategic behavior.” (A clear concession of the indeterminancy of game theory models, and I might add of the work of what I call the Post Chicago Conjectures about strategic behavior.) But, we should not be surprised. Over forty years, and thousands of articles in journals of law or economics, ago, Nobel Winner Stigler wrote: “No one has the right, few the ability, to lure economists into reading another article on oligopoly theory without some advance indication of its alleged contribution.

3. Experimental Economics The behavior of oligopolists in general and duopolists in particular has been the subject of considerable interest and analysis by experimental economists. A recent survey article identified more than 150 published papers dealing with one or more different experiments designed to test the market behavior (mainly price and quantity of output) of oligopolists – mainly duopolists – under more than 500 different parameter constellations.

On the issues here today, the results can be easily summarized:

• Duopoly behavior is highly circumstantial;
• Conduct and performance vary along a continuum bounded by perfect competition and perfect monopoly;
• Many of the experiments had indeterminate outcomes;
• Many of the results were weak and not significant statistically; and, finally
• A surprising number of the outcomes were inconsistent with received theory and our economic intuition.

4. Evidence from other sectors served by two dominant firms. Duopoly (top two firms with 80% or more share of the relevant market) is surprisingly common in the general economy. It is everywhere in small to medium sized communities and in rural areas in particular. And, it is quite common among well known national brands. We have identified about 30 duopolies and are examining the “effectiveness of rivalry” in them and more particularly any evidence market failures sufficient to warrant substantial government involvement in constraining or obligating market behavior. These include:

• Moodys and S&P
• Fed Ex and UPS
• Pepsi and Coke
• Macys and Gimbel Department stores
• Home Depot and Lowes
• Kodak and Fuji Film
• MCI and AT&T in the early days
• Lexis/Nexis and WestLaw
• Dish Network and Direct TV
• Air Canada and Westjet in the Canadian Air transport market
• Gillette and Wilkinson Sword
• AirBus and Boeing

Are these markets perfect and without flaws? Are they replicas of the BB duopoly? Of course not. But a fair assessment of the usual indices of market conduct (behavior toward rivals and consumers) and performance (profits, progress, innovation, etc.), there is no support for the proposition that duopoly requires government intervention. There may be such evidence, but it is not in the behavior of duopolists in other sectors.

5. Views of competition policymakers? Our paper cites numerous quotes from DoJ, from FTC, from European and Asian competition policy authorities, as well as to judicial language from the Supremes and lower courts. But, the bottom line is the absence of a scintilla of support for connecting market structure per se to unacceptable performance.

6. Some evidence of performance of the BB duopoly. We have adduced lots of evidence about the actual performance of the BB duopoly of telcos and cable, but

finance-chart

Excessive profits? Margins of BB suppliers in line with the S and P 500 for 2008 and on average for the past five years.

Excessive returns to shareholders? Returns on invested capital for BB suppliers are well below the S&P average for 2008 and on average for the last five years.

Suppressing investment? Broadband duopolists ploughing back over 60% of cash flow from operations into capital expenditures. That is well above the average from our sample of S and P 500 companies. The two largest BB investors in 2008 (VZ and T) combined for about five times the amount provided to NTIA and RUS in the BB stimulus package.

Jobs? BB suppliers use substantially more labor for dollar of output than the S and P average. Thus, a shift of revenue to the BB access provider sector from others will create more jobs, which of course is precisely the point of the BB stimulus package.

There is more. But, we have not been able to find economic evidence of conduct or performance measures that suggest market failure or signal what kinds of regulations might improve BB performance.

What are the implications of all this?

First, our message to believers and advocates of the view that duopoly is the problem is drawn from Casey Stengel. You should as we have “Look it up!” There is no evidence to support a structuralist view of the need for common carrier regulation. The evidence we find suggests the Scotch Verdict: Case not proven.

Markets are imperfect, but so too are government regulatory programs. Again, you can look it up. In our paper we emphasize the differences in type one and type two errors, that is the costs or regulating too much v. regulating too little. This work paired with the findings of others who have studied the costs of regulation suggests that imperfect government is likely to be more costly to consumers than the market imperfections they are designed to address.

Our work has implications for ex post v. ex ante regulation. In English, between passing rules to ensure that nothing bad happens vs. waiting to address market failures one by one as they arise. (In that regard I refer you to the well reasoned FTC staff report.)

We have found nothing of consequence to support a case for common carrier regulation based on market structure, nor on international comparisons, nor on two or three instances of market conduct. Commonsense suggests that it must be based on a thorough consumer welfare oriented cost-benefit analysis of the conduct and performance of markets AND of the well known infirmities of government efforts to manage competitive processes.

Ms. Sharon Gillett, Chief
Wireline Competition Bureau
445 12th St., SW
Washington, DC 20554

Regarding the Pending Net Neutrality NPRM

Dear Ms. Gillett:

This letter is motivated in large part by Chairman Genachowski’s recent announcement of his intention to launch a rulemaking to strengthen and extend the Commission’s Net Neutrality principles. Its purpose is to raise some issues and suggest specific terms of inquiry that we believe will assist the Commission in its solicitation of the facts and analyses it must have to devise consumer-centric rules.

We commend the Chairman and the Commission for undertaking to resolve issues growing out of various contentions about the value of “net neutrality,” “open networks,” “nondiscrimination” and how best to assure their attainment without imposing barriers to achievement of other Commission goals. Addressing these new, yet-to-be defined objectives in the context of other long standing, statutory goals — fostering investment and innovation, encouraging universal network availability, maintaining low rates for network services, balancing the advantages and disadvantages of markets and regulation – is a monumental undertaking that will shape the development of one of our greatest economic and social assets – the Internet.

We are delighted by the Chairman’s insistence that data and analysis be provided by all stakeholders – both defenders of the regulatory status quo and proponents of regulatory change – and hope that the Commission’s able core of staff analysts will accord no decisional significance to the rhetoric, opinion, jargon, “factoids,” historical revisionism and unsupported conjecture that frequently creeps into what purports to be policy analysis.

The Commission already has a rich record, full of reliable facts and analysis germane to “net neutrality.” The record has been compiled in the context of stakeholder responses to earlier proceedings that raised issues and posed questions that will be quite material in the new rulemaking. Notable in this respect are notices related to Commission efforts to formulate a National Broadband Policy; to explore the operation of markets for wireless services; and to gather information on investment and innovation in wireless markets. In addition, the Commission has adduced a voluminous record, much of which reaches issues likely to be raised in the context of “net neutrality”, in previous years in proceedings related to, among others, universal service, intercarrier compensation, spectrum licensing, and regulatory forbearance. Again, we urge the Commission to comb the public responses in those proceedings for data and analyses bearing on the new, proposed net neutrality rules. There is much of value there.

While there is much in the current record to inform new rules, we believe that inclusion of the following suggested terms of inquiry would be helpful in complementing and expanding the record – and do so in keeping with the Chairman’s pursuit of facts.

1. What should (will) be the specific public policy goals and figures of merit for evaluating alterative courses of Commission action in this proceeding? The FCC has enormous latitude under the Communications Act to frame the four corners and depth of the “public interest,” which it is generally obliged to advance in all its rulemakings. The expansive bounds of that latitude have been reflected in changing emphasis over the years in one rulemaking to the next as the Commission alters the elements included in the public interest, as well as the weights accorded individual ones.

The Commission should consider the impact of its proposed rule changes on our macroeconomic performance. This is especially important given a) our current macroeconomic distress, reflected in continuing loss of jobs, low growth prospects, stagnant productivity and other negative indicia of economic performance and b) government wide efforts to find ways to stimulate the economy, including providing funds to stimulate broadband deployment. In this context, it is entirely appropriate, if not obligatory, for the Commission to consider the potential impact of “net neutrality” proposals on the economic performance of the economy – economic growth, productivity in other sectors and, of course, job preservation and creation. It is well established, and frequently recognized by the Commission, that broadband networks and services have enormous potential for stimulating economic activity, including jobs, in other sectors. Whatever benefits may be attributable to FCC regulation in pursuit of “net neutrality” ought to be judged in terms of their impact on the broader economy. Relatedly, the impact of the proposed rules on closing the bothersome and highly publicized “digital divide” – reflected in millions of “unserved” or “underserved” households — should be assessed.

“Universal service” has been a goal for over seventy-five years, but within that context a variety of other objectives have been identified – investment, fairness, innovation, level playing fields, competition, efficiency, transparency, real income re-distribution, closing the “digital divide,” fostering technological advance, and eliminating rate structure subsidies to name just a few. It is critical for the Commission to be definitive and clear about the goals it is pursuing in this proceeding, while making clear how the means of assuring an “open” Internet mesh with other legacy goals.

2. Where are the specific market failures to be addressed? What role does concentrated market structure play in the case for regulation? What has been the overall record of performance of Internet access providers and relatedly what are the main elements of unsatisfactory performance that will be addressed and remedied by the new rules. Our sense is that the evidence of market failure is based largely on the concentrated structure of markets for Internet access and three or four cases of operator “misconduct”. While natural monopoly has long been a consensus rationale for rate and service conduct regulation, there is little factual basis in the record demonstrating that market concentration (a characteristic widespread among sectors of the Internet Value Cluster) is sufficient basis for regulation. At the end of the day, consumers care about market performance and the Commission’s inquiry should reflect that concern.

3. What, if any, potential “government failures” should the Commission guard against? Many advocates will call attention to the case for free markets, as they have traditionally done in a wide variety of regulatory proceedings. While the case for markets has been expressed in both empirical and theoretical terms, the infirmities of government regulation are often merely implied or mentioned in passing by reference to unanticipated or unintended consequences. Advocates often refer generally to regulatory lag, regulatory uncertainty or regulatory capture by special interests. However, the Commission could usefully insist on a full briefing by stakeholders – facts and analysis – of concerns about imperfections in regulation, potential “failure”, or costs attributable to well meaning government actions to offset whatever market failures it finds. In this context, Professor Stiglitz, formerly Chairman of the President’s Council of Economic Advisors recently wrote:

“Anyone who has watched the U.S. government in the last seven years is well aware not only of the possibility of government failure but also of its reality. In some cases it is a matter of incompetence, in others of corruption, in still others it is a result of ideological commitments that preclude taking appropriate actions. In some cases it may be hard to distinguish the relative role played by each. Government programs can be subverted.”

4. What are the costs and benefits of alternative courses of Commission action? Numerous regulatory scholars, analysts and practitioners favor cost-benefit analyses as means to evaluate regulations. No Commission action, or inaction, is neutral inasmuch as the exercise of any policy alternative will create both costs and benefits. These will fall unequally on different supply-side stakeholders; on different classes of users and types of consumers; and be realized in a variety of ways. Focus on costs and benefits makes imperative a clear statement of goals and purposes which can provide frames of reference for assessing costs and benefits – innovations encouraged or foregone, jobs created or lost, investment incented or discouraged, broadband network diffusion accelerated or delayed, consumer welfare destroyed or created. Any rule change imposed by the Commission will do some of each and the Commission’s analysis will, hopefully, reasonably assess all appreciable costs and benefits – particularly those to consumers as a whole and to different demographic categories — attributable to its actions.

5. How should “openness,” neutrality,” “nondiscrimination,” and other notions reflected in concerns expressed by Internet stakeholders and policy advocates be defined? How can the definitions be made operational in ways that draw bright lines between what is permitted and what is not permitted? The Commission’s new rules will likely mandate certain operator behaviors while forbidding others. The record of controversy to date makes it is almost certain that whatever new rules the Commission adopts will be challenged in Court and that final resolution of the rules as guides to firm behavior, investment and innovation and other critical management decisions, will during that period be subject to considerable uncertainty. Such regulatory uncertainty can be particularly costly in this dynamic sector in which technology, tastes, market structures, and other technoeconomic conditions are changing so rapidly. Given the technological dynamism and rate of change in the marketplace, regulatory uncertainty is a barrier to consumer and economic welfare-enhancing innovation. Clarity in definition, intent and applicability of any new rules is needed to minimize these potential costs.

6. What impact will the new rules have on the growth rate of penetration of broadband Internet usage? What impact will they have on the rate of diffusion of innovations made by applications and content providers or on the goals set forth in the Commission’s NOI in re: constructing and national broadband policy? The Commission has made clear its concerns about innovation and the diffusion/market penetration of Internet technologies in previous notices, in particular those regarding a National Broadband Policy, the state of competition in wireless, and investment/innovation in wireless. Any new rules implemented in the name of net neutrality, open networks or related objectives will very likely have a significant impact on innovation, investment, and the pace and overall character of broadband deployment. The record to date is deficient and can usefully be improved with more facts and disinterested analysis.

7. What impact will alternative rules have on rates paid for Internet access by consumers in the aggregate; on prices paid by different classes of consumers; and, on the rate of penetration? These questions are raised in the context of the Commission’s pursuit of a National Broadband Strategy or Plan, but can usefully be put in the more specific context of discussion of the net neutrality regulations.

8. What have been the major Internet-related innovations in recent years? Are these in the core or on the edge? What (level of) benefits have accrued from each? How if at all have they been encouraged or hampered by regulation? What effect will the proposed rules have on this aspect of sector performance? So far as we can discern, there is insufficient evidence in the record to date in support of various claims about the source of innovation, its value to consumers, and the impact of regulation on incentives and likely performance of different members of the Internet Value Cluster (providers of networks and components, applications, and content). Given the importance of innovation to Internet users and to other sectors of the economy via external stimulus from the Internet, it is imperative for the Commission to develop a strong factual and analytical record on this point.

9. What specific wireless market failures require regulatory remedies? To what extent will evolution of the wireless market place either magnify or ameliorate those concerns? What if any costs to the consumers related to rates, options, service quality, innovation or other regulatory objectives might reasonably be expected to offset the expected benefits of regulation to the wireless sector. The Commission has ongoing a separate proceeding designed to address current performance of the wireless sector. It is well known that the principal innovations in wireless networks take the form of, and have the practical impact of, utilizing scarce bandwidth more efficiently. As bandwidth scarcity becomes more acute as a result of booming growth in demand for bandwidth intensive services coupled with lagging availability of new spectrum, it is imperative for the Commission to understand fully the impact of any restrictions, in the name of net neutrality, on the ability of wireless operators to manage their networks in ways to assure maximum throughput and efficiency.

10. What role do price discrimination, service discrimination and, more generally, differential treatment of different customers play in other IT sectors; in other sectors of the economy? What are the costs and benefits to consumers in the aggregate; to individual consumers? What makes the Internet access provider sector worthy of discriminatory regulatory treatment among firms in the Internet Value Cluster in this regard? A key question in this context is the extent to which consumers or users in general place equal value on all content and the extent to which carriage of all content occasions the same costs – conclusions clearly implied by a requirement to treat all traffic and content the same. In the event of excess demand for bandwidth – that is in circumstances where there is a shortage of bandwidth – what are the alternative means for allocating available bandwidth and what are the (de)merits of each?

It may well be that the Commission would specify these points of inquiry in its impending Notice of Proposed Rulemaking. However, given their importance, in our view, we believed it worth the effort to spell them out and suggest their inclusion.

Respectfully submitted,

Larry F. Darby, Senior Fellow
The American Consumer Institute
Center for Citizen Research
1701 Pennsylvania Avenue, NW
Washington, DC 20006
Darby@theamericanconsumer.org

CC: Chairman Julius Genachowski
       Commissioner Michael J. Copps
       Commissioner Robert M. McDowell
       Commissioner Mignon Clyburn
       Commissioner Meredith Attwell Baker
       Ms. Ruth Milkman, Wireless Bureau Chief
       William T. Lake, Media Bureau Chief
       Paul de Sa, OSP Chief

A keystone in the case for more regulation is that the “market” has “failed” to provide consumers protection from the exercise of monopoly power. Given the resources committed to making the case for regulation, the evidence for that is surprisingly both narrow and shallow. It is summed up in significant measure by repeated assertions about “cozy duopoly” of cable and telco broadband network providers – and this notwithstanding the lack of any evidence of a factual nature that duopoly generally leads to unsatisfactory performance .

The structure of the questions posed to the panel invited responses finding market failure and the need for more regulation. Unfortunately, the panel did not offer much in the way of facts about the extent of concentration and almost nothing about what consumers really care about, namely, recent wireline and wireless market performance reflected in enormous new investment, new and improved service offerings, and falling prices. (As Casey Stengel famously said, “You can look it up”) Panelists variously referred obliquely to monopoly power while others noted that many consumers have several choices. Clearly the extent of competition varies from market to market and is (surprise, surprise) the least vigorous in outlying areas where loop lengths are long, households scattered, and unit investment/operating costs prohibitive for wireline platforms.

Panelists addressing the issue agreed that wireless platforms are significant potential competitors, but that more spectrum will likely be needed to enable its timely and economic expansion. The Commission can draw support for requiring greater disclosure by platform providers of service terms. Panelists addressed issues related to bundling, vertical integration, and price discrimination, but notably no panelist supported regulation on those grounds and some in fact found no basis in them for the Commission’s regulatory intentions.

All in all, a fair assessment of the content of the discussion suggests little basis for disagreement with what we wrote last summer in BusinessWeek, “Federal, state, and local governments should create an environment that will attract financial investors and induce company managers to use cash to develop high-speed networks. High taxes, intrusive price regulation, and competition from government-financed networks are inconsistent with a rational broadband policy rooted in private investment.”

This ConsumerGram is another in a series focusing on facts germane to issues arising in current policy debates and the merits of alternative courses of regulatory action.

Failure to Meet Consumer Needs Should Be the Test for New Regulations

It is fair, nay obligatory, to ask: “What is the rationale for imposing ‘net neutrality’ or any form of rate and service regulation on the wireless sector – a sector that has evolved to its current state more or less free from wireline telephone economic style rules and government micromanagement?” Put differently, is there any evidence that wireless network providers are failing to meet the requirements of reasonable public policy objectives or, more specifically, the needs of their customers? As discussed herein, frequently cited characterizations of market failure in the wireless sector have been largely disproven, notwithstanding skeptics among us, by a combination of technological change and evolving market behavior by network suppliers, applications providers, equipment device manufacturers and, most importantly, the actions of consumers. Our review of the record reveals little basis in fact, and none from competent consumer welfare analysis, to justify rate and service regulation of wireless networks, which by standard performance measures, and comparisons with other countries, are performing admirably.

The first question that must be resolved in deciding the optimal mix of regulatory restraints and market forces is: “What is the alleged harm experienced by consumers and is it evidence of remediable market failures?” Market failure, like beauty, is in the eye of the beholder. Use of discrete and limited examples to prove systemic market failure is a common tool used by advocates favorably disposed to regulation, stakeholders dissatisfied with the conduct of suppliers, and firms who gain market advantages from regulation. But, the real interests of consumers – lots of choices and the freedom to explore those choices at prices they can afford requires that regulatory issues should not be resolved on theory or philosophy or individual value judgments or limited information, but on a fact-based analysis of actual consumer costs and identification of true market failure. Commendably, the FCC has made that patently clear in recent weeks through both speeches by Commissioners and senior staff and in formal Commission documents.

Market Evolution More Quickly Addresses”Failures”

The second question addresses the likelihood that markets will or will not in the natural course of events evolve in reasonable timeframes to eliminate the alleged harm or to demonstrate it does not constitute a market failure. That might be a difficult question to answer if the focus were on markets for, say, coal or another sector where technology and consumer demand are fairly stable. But, recent experience in the highly dynamic market – on both the supply side and the demand side – for wireless services suggests that market “imperfections” are being addressed rapidly and successfully by consumer driven responses by suppliers of networks, applications, and equipment devices.

To test our sense that markets are rapidly adjusting to consumer demands, we compared recent facts and analyses addressing current market structure, conduct and performance in the wireless sector with the market failures cited in two sources – a law review article by Professor Timothy Wu (Wireless Carterphone)1 and a Petition to the FCC by Skype. These market failure pieces were written barely two and a half years ago, but their conclusions and forecasts about wireless carrier behavior are still relied on as testaments to market failures and the need for government remedies. Accepting both the old and new descriptions of the sector as accurate (which many advocates may not be willing to do), it seems quite clear that most of the Wu and Skype allegations of market failure are no longer valid, even if they were accurate when alleged. Firms in the sector are responding to signals from consumers and eliminating earlier sources of discontent.

Chairman Genachowski had it absolutely correct when he reflected recently on the rate of progress in the wireless sector and emphasized our inability to “predict with confidence” how the revolution in mobile broadband will ultimately play out. In the context of the technological and economic dynamism of wireless markets, it is extremely difficult to identify and quantify the expected costs, or benefits, of imposition of static regulation.

Our comparison of a) the fears and concerns and conjectures and forecasts of market conduct expressed two years ago in the context of making the “Wireless Carterphone” case for applying equipment interconnection requirements imposed three decades ago on the Bell System wireline monopoly with b) the facts of current market performance makes indicates to us that early market infirmities are being addressed and whatever perfections remain do not demand new government programs to address them.

Regulation Is Not Costless to Consumers

The third question relates to consumer costs and benefits of using government intervention as the tool for offsetting perceived market failures. Like markets, governments are not perfect, nor are government actions free of unwanted or unintended costs. Nobel prize winning economist Professor Stiglitz, formerly Chairman of the President’s Council of Economic Advisors, recently wrote: “Anyone who has watched the U.S. government in the last seven years is well aware not only of the possibility of government failure but also of its reality.”2 We take recent remarks of FCC Chairman Genachowski as in substantial agreement with the need to take a realistic view of not only market imperfections, but of government imperfections as well. The Chairman recently emphasized the importance when considering new regulations of “getting it right,” while also being candid about the Commission’s mixed history of doing so: “The Commission’s history in this area holds great examples of success…But there are also examples of failures…In short, at times the Commission has gotten it right, and at times it has gotten it wrong.”

In Short

A consumer-oriented assessment of the need for imposing new government restrictions or mandates on suppliers of wireless networks, equipment or applications can only be performed after a careful accumulation of facts, not outdated conjectures, analysis of the infirmities of both markets and government action and the impact of same on consumers.

Footnotes:
1. International Journal of Communication, Vol. 1, 2007.
2. Joseph E. Stiglitz, “Government and Markets: Toward a New Theory of Regulation”, Government Failure vs. Market Failure: Principles of Regulation, Available online at: http://www.tobinproject.org/twobooks.
Posted October 12, 2009

This is the first in a series of ConsumerGrams that attempt to provide a factual basis related to some of the key issues the Commission will address.

                  (To see the chart in PDF, click here)

Perhaps the most important reason for regulation is the existence of market power. There are several potential indicators of market power drawn from measures of market structure (monopoly for example), market conduct (predatory pricing for example), and, most importantly, abnormal returns on investment or high profit rates. Advocates for additional regulation rely on assorted rationales, but a common and popular theme is that network providers have substantial power over price and use that power to earn anticompetitive profits and returns on investment. The facts suggest otherwise.

The accompanying table reports calculations based on data taken from audited financial statements. It looks at indicia of size and profitability for a selection of firms: some from the IT space and others from the energy or pharmaceutical sector. All are compared to the Standard and Poor (S&P) average. The data were recently accessed from MSN and can be verified at http://moneycentral.msn.com/investor.

The first three columns contain for each of the companies in the sample three different measures of profit – the profit margin (net income divided by sales); the return on invested capital (equity and debt); and the return on assets used in production. Column 4 shows revenue growth in the past five years. Columns 5 and 6 report ratios of stock price to cash flow or earnings. The last two columns indicate the relative size of the firms in the sample as measured by annual sales and the total market value placed by investors in outstanding stock (“Market Capitalization” equals share price times the number of outstanding shares).

Readers will be interested in different comparisons, but the data make clear that, according to each of these measures, operators of broadband networks (Comcast, Time Warner, AT&T and Verizon) earn relatively modest returns compared to other major companies both inside and outside the Internet sector. Indeed, in each case, returns are below the average for firms in the S&P 500 index and substantially below those posted by other firms in the Internet Value Cluster. For example, Google’s profit margin is 2-3 times greater than earned by network providers and twice the average rate for S&P 500 firms. The comparisons are even more striking in the case of returns to investors or on assets. Return on investment for network providers are a fraction of those enjoyed by the average of all S&P 500 firms and, depending on the measure and company, are between 10% and 25% of those earned by Google. These earnings are the average for the past five years and are thus insulated somewhat from cyclical effects associated with the current recession.

Conclusion

Firms included in the table provide a variety of different services, each of which very likely earns a different return. Providers of broadband access – mainly cable television and traditional telephone service providers – are no exception. A variety of conclusions might be adduced from the table, but one that clearly stands out is that earnings and returns of network access providers do not reflect market power and do not provide the basis for concluding market failure that should be addressed by new regulations. Proponents of regulation should look elsewhere.

Posted October 8, 2009

In the Matter of A National Broadband Plan for Our Future
GN Docket No. 09-51

REPLY COMMENTS OF THE AMERICAN CONSUMER INSTITUTE

The American Consumer Institute (“Institute”) hereby submits its reply to comments responding to the Federal Communications Commission (“FCC”) Notice of Inquiry (“NOI”) in the above-captioned proceeding.

I. INTRODUCTION
In our initial comments we emphasized our support for the Commission’s recognition of the key role of consumer welfare created by firms’ conduct and performance in its definition and execution of a National Broadband Plan (NBP). We urged the Commission wherever possible to assess, and require others to assess, costs and benefits of alternative policies and courses of action under the NBP and to use the welfare of consumers as the benchmark of merit. We emphasized that the goal of universal broadband access cannot be achieved without substantial private sector capital expenditures to underwrite the enormous fixed costs of broadband networks. We attempted to provide some insights into how government action impacts private sector investment incentives. We called attention to the extraordinary tax burdens imposed by state and local governments on broadband networks and services; to their pernicious impacts on the willingness and ability of firms to invest in broadband networks; and, to their inconsistency with any reasonable construction of a national policy to promote universal or widespread access to broadband networks.

We encouraged and suggested guidance for Commission efforts to balance the imperfections of markets and the infirmities of regulatory interventions, by fully and realistically assessing the comparative (dis)advantages of each, while spurning simplistic and rhetorical substitutes for substantive analyses of costs and benefits. We emphasized the limiting role of demand in our broadband performance rankings and encouraged government wide focus on users through assorted demand enabling initiatives.

We recognized the key and expanding role of wireless as an alternative broadband path and recommended several steps to recognize that role, including providing more spectrum and addressing a variety of regulatory barriers at the state and local level that slow the ability of operators to respond to consumer needs.

Our comments concluded by addressing the thorny issue of rate differentiation (discrimination) and set forth a consumer welfare based case for allowing operators to tailor service offerings and rate structures to reflect the diversity of consumer wants and accurately to address detailed consumer preferences. Our comments emphasized the widespread and indispensable role of price and rate discrimination in the general economy and among Internet applications providers. They called attention to the costs of regulatory intervention to impose “one size fits all” constraints on operator business plans and service offerings. We found that reasonable price discrimination has a long history in regulated industries; that it has been actively promoted by the Commission; that it is an indicator of rivalry, not monopoly; that its application can increases consumer welfare; and that poorly designed, if well intended, regulatory efforts to suppress price differentiation will diminish network investment and impose immeasurable costs on consumers.

II. OVERVIEW OF THE AMERICAN CONSUMER INSTITUTE REPLY
Responses of commentors in the initial round reflected both the depth and breadth of the Commission’s Notice. It is impossible to summarize or even characterize in more than the most general way the voluminous comments filed. Our review and analysis of these comments, as well as our reply below mirror the limits and focus of our original comments. Accordingly, we shall focus on a) calls for reregulation and their basis; b) the role of international rankings; c) the consensus on the importance of investment to assuring universal broadband access; d) policy relevance of market structure and seller concentration in particular; e) the absence of any clear definition or guidance respecting regulation of “price discrimination;” e) the negative impact of taxes on investment and pursuit of the goal of universal access; and f) the role of markets and government in the wireless sector.

III. CASE FOR COMMON CARRIER REGULATION OF INTERNET ACCESS SERVICES
A recurring controversy in the comments focused on the adequacy of markets and relatedly the need for government regulation as means for achieving our national broadband goals. In fact, that issue fairly divides the comments into two camps, which may be thought of as the “Reregulators” and the “Market Defenders.”

The Reregulators put forth a case for imposition of common carrier regulation on Internet access provision. The core of the case for common carrier regulation was put forth for the most part in six sets of comments (CFA/CU, Free Press, Google, Media Access Project/NAF, NASUCA, and Public Knowledge). Taken together the comments summed to several hundred pages and the best we can do here is to try to characterize them fairly. All of these commentors support greater government regulation of the terms and conditions related to services offered in the Internet access market. While the term “common carrier” regulation is not generally used, it is fair to characterize the recommendations as recommending application of that status to broadband network providers. That is in fact the practical effect of the common recommendation that the Commission reclassify Internet access services as a telecommunications service rather than as an information service and thereby subject provision of Internet access services to Title II regulation.

The main complaint of the Reregulators is that both markets and government have failed in recent years. They cite indicators of failure and assert a variety of causes.
Two general indicators of market failure are relied on by the Reregulators: a) our relative rank vis-à-vis other countries according to some studies and b) concentration of sellers (duopoly). From time to time they make more explicit charges including direct or oblique references to bad economic performance including a) lack of investment, b) rising rates, c) low service quality, d) lack of innovation, d) profiteering, e) collusion, and f) anticompetitive conduct.

Critics and Reregulators cite several causes of failure including most notably: a) lack of competitors (“duopoly”); b) failure of existing competition (“cozy duopoly”); and c) lack of oversight and regulation by the FCC. They credit the concentrated market structure as the main source of market failure, but refer from time to time to assorted elements of conduct—most particularly efforts by carriers to manage or otherwise impact the character of network traffic. Finally, they argue that the FCC has wrongly and without good cause reduced its role in controlling the conduct of incumbent carriers on matters related to pricing, investment (level and location), service quality, and with respect to network management.

IV. LIMITED POLICY RELEVANCE OF INTERNATIONAL RANKINGS
Several respondents took the occasion to call attention yet again to the results of various attempts to compare and rank US broadband performance vis-à-vis other countries. A fair minded analyst reading competing claims about whether we are ahead or behind, of whom, how far, why, and, indeed, what is the correct metric would be forgiven for simply ignoring the entire debate on grounds that it is in the end completely indeterminate. That same analyst could make the argument for both sides. The core problem has been widely debated in the context of comparing “apples and oranges.” One can certainly do so and may find that they are similar or different depending on the characteristics chosen to depict them and the tastes or values of the evaluator. And, without regard to these similarities or differences, many of us find one superior to the other, but not necessarily in the same rank order. So it is with international comparisons of broadband performance.

It is very likely that the US is behind according to some metrics and but ahead using others. That said we find no value in spelling out the relationship between different metrics and different ranks, since our international rank should not be the driving force behind the call for a national broadband policy or for any particular element of that policy or strategy. The need for one, or not, does not depend on our rank, but rather is based on the impact of having one or not having one on our overall economic performance. Put differently, the impact of our economic development path should be the main driver and that is independent of whether we are ranked first, fifth or twenty-fifth in the world by one or another individual or cluster of metrics. The rationale for adopting or not adopting a national broadband strategy and the elements of that strategy are both independent of our rank.

The discussion of our rank is driven largely by those critical of US communications policy in the past two or three decades. Ranks are used to indict policies that some advocates do not condone – indeed, disapprove of quite shrilly. Thus, reports of inferior rank are used to justify abandoning recent policy trends and embracing new ones, notwithstanding the lack of clear connection between past policies and current rank. Inferring causation from coincidence events is a well known logical fallacy. Notable in this regard as well is the absence from most critical discussions of our relative rank of any relationship between policies in countries ahead of us and their rank.

Despite persistent efforts to link them, there is absolutely no connection between any measure of our international rank and assorted policy proposals advanced and justified by reference to our poor international performance. Thus, net neutrality, open networks, reregulation, nondiscrimination requirements, separate subsidiaries, reinstitution of common carrier regulation and other proposals must be evaluated by the Commission on their own merits measured in terms of the costs and benefits expressed in terms of consumer welfare. These proposals should not be accepted or rejected on the basis of how someone at the OECD or another institution chooses to measure broadband performance. Too much of the argument takes the form of “We are behind several countries (you pick the study and rank), therefore we should change our policy approach (you pick the policy to insert here).” The Commission must insist on more in the way of data and analytical support for policy proposals. And, as we have consistently urged, the focus of that should be on consumer welfare.

This is not to deny a useful role for international benchmarking. It is intended to suggest commonsense bounds on their use. Our examination of the policies being pursued in other countries suggest some that might well be imported – tax incentives, assorted regulatory incentive schemes and others. But, we repeat the Commission should evaluate these on their own merits and not make a decision based on the relative rank of those countries who have adopted them.

At the end of the day, the relevant benchmark is where we could and should be if we adopt optimal policies, not where we stand relative to other countries. The focus on the NBP should reflect careful analysis of the relationship at the margin between policy goals and policy means.

V. CRITICAL ROLE OF INVESTMENT AND INCENTIVES IN THE NBP
Private sector investment should be a primary objective of the national broadband policy. In our initial comments we emphasized the frequently neglected but obvious truism that high levels of investment will be required to satisfy any reasonable goal of universal availability of broadband services to American households; and, that pursuit of other goals through regulatory means would have an impact on the ability and willingness of firms to invest. Financial market investors and capital budgeting managers within firms are sensitive to risk, expected growth, rates of return and real market options associated with any given commitment of scarce capital. Elements of the National Broadband Policy, the level of taxation and the amount and form of regulation in particular, will impact each of these either as a constraint or incentive to invest in broadband networks.

Investment is not the only goal of any broadband plan, but it is necessary and deserving of primacy. Without capital expenditures to increase the number of networks or to extend and deepen existing ones, there can be no substantial improvement in citizen access – universal, open, neutral, fairly priced, or otherwise. Explicit or implied in the Commission’s NOI are dozens of goals, objectives, or purposes, some major and some less so. Nevertheless, private investment in broadband networks should be regarded by the Commission as a primary objective of any National Broadband Plan. Plan elements and policy proposals advanced and justified on other grounds should be evaluated by the Commission in the context of their impact on incentives, willingness and opportunities for investors and managers to use scarce capital – capital with innumerable alternative uses – to construct or improve broadband networks.

Respondents disagreed sharply on many matters, but there was near unanimity on the importance of investment. Free Press opens its comments with the observation that: “…In the Notice of Inquiry for the National Broadband Plan for Our Future the Commission rightly recognized the importance of thinking about broadband and Internet policy in terms of infrastructure policy.” Google implored the Commission to focus on three critical dimensions of broadband networks as platforms for providing consumers with “optimal” access to the Internet. The first two of these clearly reflect concern for investment: “…the availability of broadband infrastructure on a ubiquitous basis…”[and]…the robustness of broadband capacity sufficient to support Internet access…” While less expansive and explicit, Public Knowledge, et al. also recognized the need for investment. Thus, they urge the Commission to review past policies in part on grounds that doing so will assure that “…efficient investment in broadband infrastructure is encouraged. In the context of spelling out some limits on competition, Free Press notes “…the need for massive investment in networks…” CFA and CU implicitly, but unambiguously, embrace the goal of high rates of investment by declaring at the very beginning of their comments that the Federal Communications Commission (FCC) should: “…focus its national broadband plan on the achievement of the central goal of the Communications Act – universal service.”

There may be others, but our sense is that only NASUCA opposes private sector investment as a principal broadband policy driver. It argues: “It is the nature of profit-seeking private investment that limits the growth of broadband.” On that basis they do not address the impact of regulation on private sector capital formation. Having eliminated private investment and the profit motive from consideration, the NASUCA comments are consistent in not addressing the impact that adoption of their recommendations for more regulation would have on capital formation.

In contrast to the agreement on high rates of capital formation as a goal of the National Broadband Policy, there is less agreement on the means for achieving that goal. We emphasized in our comments, and continue to believe, that current high levels of taxation of broadband networks at the state and local level, combined with the universal service surcharge on interstate services strips away enormous amounts of cash from firms that might otherwise provide funding for broadband investment and while also reducing expected returns from investing in network related assets. Broadband taxes impact both the costs of providing broadband services and the revenue derived from broadband networks. Cost reduction tax strategies would include a) accelerated depreciation which allows expensing and short term tax reduction while permitting more rapid recovery of network investment and b) investment tax credits which would increase the expected return and investment and willingness of firms to invest. Both of these approaches are especially attractive in the current economic environment in which the pace and direction of economic recovery will be substantially influenced by private sector investment. We call attention again to the destructive impact of current levels of state and local taxes on service provided by broadband networks. These exceed twice the level of other consumer goods and services, while being extraordinarily regressive. We pointed out as well that wireless services are taxed at rates well above the average for all services. The (regulated monopoly) basis for the extraordinary and excessive levels of taxation on broadband network providers was long ago rendered obsolete by technological and economic change.

Clearly the level and form of taxation matter to the level and composition of broadband investment, but so too does the extent and form of regulation. Unlike investment in voice networks by regulated and protected monopoly carriers of an earlier generation, or by cable companies free of intermodal competition, the commitment of capital to broadband networks is subject to enormous uncertainty about the prospect of positive returns – their timing, their level and indeed if they will in fact materialize at all. Investors are and will be sensitive to the extent to which the Commission incorporates as part of its National Plan and recommendations to Congress restrictions and obligations on network infrastructure providers that will have a material impact on the ability of firms to grow, to pursue reasonable network management and pricing practices, to be free of regulatory uncertainty and delays borne of traditional regulatory processes.

Comments of those critical of the current performance of the industry and recommending reversal of the gradual withdrawal of regulation and a return of common carrier regulation are without exception offered without any consideration of the effect of doing so on risk, return, and growth prospects as viewed by investors who must supply the scarce capital needed for achievement of high rates of capital formation and timely achievement of the universal service goal. Notable in this respect are recommendations related to restrictions on the ability of firms to differentiate rate and service packages (as opposed to “one size fits all” offerings); requirements that infrastructure providers subsidize, through below cost wholesale rates, potential competitors in the retail market; that firms be required to build out networks without regard to the relationship between expected costs, revenues and cash flows; structural separation of network ownership and provision of network services; reclassification of broadband, Internet access as a “communications service” subject to full Title II regulatory schemes; imposition of vaguely defined nondiscrimination requirements on access rates; restrictions on the ability of operators to manage networks in ways that are privately beneficial without being publicly detrimental; and imposition of regulation on the basis of market structure alone (alleged cozy duopoly) and without regard to conduct or performance.

There seems to be a presumption in some quarters that it is a simple matter of “Build it, and they will come!” as a description of the relation between investment and likely take up rates by users. This, notwithstanding the evidence that many potential household users are not likely under current circumstances to subscribe and without regard to the price and quality of service offered by broadband providers.

VI. CLAIMS OF DUOPOLY OR MARKET STRUCTURE ARE INSUFFICIENT BASIS FOR IMPOSING REGULATION.

As discussed earlier, proponents of regulation offer a variety of rationales. Evidence of market failure offered as justification for greater reliance on government controls of market behavior is varied, for the most part quite limited and often inaccurate.

While other rationales for regulation are offered, the principle rationale focuses on market structure and, quite specifically, on the limited number of competitors. The comments of “Reregulators” typically misperceive or misstate the relationship among the number of suppliers, investment and consumer welfare. The first and foremost mistake is to equate the number of suppliers with the quality of competition and to assume, without further inquiry or analysis, that increasing the number of competitors, without regard to means, will increase investment and consumer well-being. The following comments are illustrative:

• The FCC has allowed a cozy duopoly of telephone and cable companies to dominate the broadband access market…The reliance on this cozy duopoly has been disastrous for the United States…Consumers pay too much for too little.”
• “The broadband problem in the U.S. flows from a simple policy mistake – a decision to rely upon a duopoly of telephone and cable companies to decide where and when to deploy this vital infrastructure with no overarching social responsibilities whatsoever. They have slow-rolled deployment, kept prices far above those in other nations, and emphasized bundles of services targeted to upper-income Americans built around “franchise” services…”
• “…when a market has fewer than the equivalent of six equal-sized competitors, the market just doesn’t function properly. The FCC has ignored the mountains of evidence that our broadband markets are concentrated, anti-competitive, and fundamentally broken.”
• It is also a fair question whether the further development of future competition, which in itself is not a given, would prove sufficient to deter such conduct. Importantly, the problem to be solved is inherent in the concentrated nature of the broadband market itself, rather than in a roster of actual and potential “bad acts.” In other words, the flaw is structural, not behavioral.”
• “The FCC has allowed a cozy duopoly of telephone and cable companies to dominate the broadband access market… [T]he cozy duopoly dribbles out bandwidth at prices that are 10 to 20 times as high as in other nations…The reliance on this cozy duopoly has been disastrous for the United States… [W]e have fallen from third in the world in broadband penetration and now are behind at least a dozen nations (15th) and, by some counts almost two dozen. Consumers pay too much for too little and the economy suffers as other nations with consumer and competition-friendly policies become the focal point of innovation.”

The relationship between market structure and market conduct has been explored in a variety of different types of studies: a) theoretical analyses, b) empirical research, and c) experimental research. None support the proposition that duopoly, per se and not otherwise specified, is tantamount to market failure and sufficient grounds for remedial government actions.

Theoretical Research. The economics literature addressing the relationship between market structure, conduct and performance is equally voluminous. It is generally inconclusive and lamentably bereft of guidance for policy makers faced with decisions about what, if any, elements of market conduct should be constrained by the power of the state. The economic theory of market conduct and performance under concentrated market structures is subsumed in a larger literature focused on the economics of “few sellers” or oligopoly. The problem is not a paucity of theory or modeling efforts. To the contrary, there are literally thousands of theoretical models of oligopoly/duopoly behavior. The problem is the lack of a model that predicts firm behavior in particular contexts and does so with sufficient accuracy and reliability to warrant its being used as the basis for policy decisions about whether, how, and under what circumstances the state ought to intervene and impose economic regulation. The author of one well known textbook concluded his review as follows: “Economists have developed literally dozens of oligopoly pricing theories – some simple, some marvels of mathematical complexity. This proliferation of theories is mirrored by an equally rich array of behavioral patterns actually observed under oligopoly. Casual observation suggests that virtually anything can happen….”

“Before embarking on the analysis, it is best to provide the reader with a word of warning…there is no single theory of oligopoly… I do not expect oligopoly theory… to give tight interindustry predictions regarding the extent of competition or collusion.” Over forty years, and thousands of articles in journals of law or economics, ago, Nobel Laureate George Stigler wrote: “No one has the right, few the ability, to lure economists into reading another article on oligopoly theory without some advance indication of its alleged contribution.” The admonition applies a fortiori today.

In summarizing his review of the literature and long litany of the assumptions and outcomes of dozens of oligopoly models, Shapiro calls attention to the forgoing caveat and then concludes: “What we are most in need of now are further tests of the empirical validity of these various theories of strategic behavior.”

Empirical Research.  If the theory is borderline bankrupt as a guide to policy, so too is the body of empirical research linking duopoly structure with anticompetitive conduct and performance. Two other chapters in the Handbook of Industrial Organization expressly consider empirical studies of the relationship among market structure, market conduct, market performance and consumer welfare, but one is hard pressed to come away with any categorical or even roughly generally applicable conclusions that might be used to inform policy in the broadband communications context.

Efforts to link market structure with market conduct and performance in matters related to prices and price setting process have not been notably successful. Thus, the authors of one popular industrial organization textbook conclude a lengthy review of empirical efforts to establish these linkages: “…the relationship between industrial structure and price setting over times remains very unclear…it is difficult to avoid concluding that, if any such links do exist, they are far from obvious and unlikely to be powerful…Industrial structure may have an important influence on price procedures….but it does not seem to play a central role in the pattern of price changes that develops through time.”

Similarly, there has been notable lack of success in establishing a relationship between market structure and profits. Early studies of structure and performance relationships identified links between concentration and profitability. The main thrust of subsequent analysis and results has been to call into question the validity of the early studies and in the process insist that concentration is only one of several variables (growth rates, diversification, buyer concentration, technological change, conditions of entry, degree of regulation, cost conditions, capital intensity, and numerous others) influencing profits and that there is no reliable one to one link between concentration and profit. A major analytical problem is that the causal relationships between structure and profits and other variables are not clearly established either in theory or by observation. Thus, any correlation between structure and profit does not imply causation.

Empirically validated relationships between market structure and innovation are even more tenuous than for pricing practices and profits. The literature provides no support for believing in general market that concentration is a barrier to innovation. Indeed, the contrary is frequently suggested. There is much support for the Schumpeterian hypotheses that market power is needed to assure the optimal rate of technical progress. The literature is vast, complex and not given to easy summary, but it is fair to say that both market concentration and market rivalry are key innovation drivers.

There seems to be consensus around what might be characterized as “competitive oligopoly” wherein the competitive part provides the spur and oligopoly part provides the reward necessary to compensate for and to incent risk taking. Thus,

“The comparative performance benefits of oligopoly over monopoly for technological innovation also has empirical support. It is well established in the economic and competition policy literature that the link between market structure and innovation is much less predictable…. But there is reasonably good evidence that neither monopoly nor perfect competition is particularly beneficial for investment in research and development or deployment of new technology.

Finally, there are indications that concentration is the result of the competitive processes, as Nobel Laureate Harold Demsetz stated:
“My own studies … indicate that the more concentrated the industry, the lower are the costs of large firms relative to the costs of medium and small firms in those industries; the difference in costs is substantial. The cost advantage diminishes to insignificance for very unconcentrated industries. I believe that is why one set of industries is and remains concentrated and the other does not. This suggests that where concentration is found, it is largely a consequence of the competitive process, and that such industry structures are derived from those techniques yielding low-cost production. Competition would have altered concentrated structures if there were no associated efficiencies; in fact, many industries remain unconcentrated or have become unconcentrated because no special efficiencies or entrepreneurial successes have called forth and maintained concentrated structures.”

Experimental Research. The behavior of oligopolists in general and duopolists in particular has been the subject of considerable interest and analysis by experimental economists who undertake to simulate market behavior with economically motivated and constrained lab participants. A recent survey article identified more than 150 published papers in recent years dealing with one or more different experiments designed to test the market behavior (mainly price and quantity of output) of oligopolists – almost always duopolists – under a large and very diverse array of circumstances. This review of the literature found experiments covering more than 500 different parameter constellations.
It is difficult in a short space to do justice to such a detailed review of such a comprehensive and diverse literature, but surprisingly the main results are easy to state.

• Duopoly behavior is highly circumstantial; 
• Performance varies along a continuum bounded by perfect competition and perfect monopoly, but not in predictable ways;
• Many of the experiments had indeterminate outcomes; Many of the results were weak and not significant statistically; and, finally
•  A surprising number of the outcomes were inconsistent with received theory and, indeed, with economic intuition.

Thus, to the point of these reply comments, there is absolutely no support for concluding that the broadband “duopoly” characterized by critics has the character identified in experimental research as a “market failure” warranting government intervention. To the contrary, conditions experimenters found conducive to competitive, non collusive behavior are frequently found in real world markets, including broadband markets here under discussion. The larger the market, the smaller is the degree of collusion. If sellers compete in price, if products are reasonable substitutes, and if marginal cost is constant, the mere presence of a second seller suffices to force the competitive equilibrium on the sellers.

Evidence from other sectors served by two dominant firms. Duopoly (top two firms with 80% or more share of the relevant market) is quite common in the general economy. In the smallest markets, local businesses are often near monopolies with competition limited by spatial considerations. Monopoly and duopoly are quite common in small to medium sized communities and in rural areas in particular. Service provision is often limited to one or two suppliers – doctors, lawyers, specialized retail establishments, schools, post offices, gasoline stations, etc. These markets illustrate the relationship between market size and limits on the number of sustainable competitors.

But, small number of sellers, duopoly in particular, is common in larger, regional or national markets as well. We have identified about 30 duopolies and are examining the effectiveness of rivalry in them and more particularly any evidence of market failures sufficient to warrant substantial government involvement in constraining or obligating market behavior. These include the following dozen well known dominant “duopolists” operating in a broad cross section of markets:

• Moodys and S&P in markets for credit rating services;
• Federal Express and United Parcel Service in package delivery markets;
• Pepsi and Coca Cola in soft drink markets;
• Macys/Bloomingdale, Gimbels (historically); Nordstroms, Lord and Taylor in shopping malls;
• Home Depot and Lowes for home improvement products or services;
• Kodak and Fuji Film;
• MCI and AT&T in the early days;
• Lexis/Nexis and WestLaw;
• Dish Network and Direct TV;
• Air Canada and Westjet in the Canadian air transport market;
• Gillette and Wilkinson Sword in the market for razor blades; and
• AirBus and Boeing in the market for jumbo aircraft.

The list is by no means exhaustive. There are numerous other markets dominated by two sellers. Our initial review of each of these reveals numerous market imperfections, but no systematic market failures that might arguably be the basis for aggressive government action of an antitrust or regulatory variety for the purpose of policing market conduct or encouraging better performance. Profits appear to be roughly normal, while market rivalry rises to the level of “workable” or “effective” competition without either predation or collusion. There are no indications to suggest a lack of innovation or product diversity, quality or change. In short, these markets lend no support to a theory that duopoly or tight oligopoly per se is sufficient reason to warrant government interference.

Are these markets perfect and without flaws? Are they replicas of the alleged broadband duopoly? Of course not. But a fair assessment of the usual indices of market conduct (behavior toward rivals and consumers) and performance (profits, progress, innovation, etc.), there is no support for the proposition that duopoly requires government intervention. There may be such evidence, but many duopolists compete.

Some evidence of performance of broadband providers. There is a substantial amount of empirical evidence available describing the actual performance of broadband providers. The Commission has already done so for much of the data in its Section 706 reports to Congress. We are sure that “market defenders” will exhaustively cite the relevant data and call attention to the lack of support for many of the charges about performance leveled by Reregulators. However, we call attention to data in the Table 1

Table 1 (Omitted)
Selected Comparative Broadband Performance Indicators

Notwithstanding claims to the contrary there are not excessive profits being reaped by broadband access providers. Table 1 makes clear that the margins of broadband suppliers are in line with the S&P 500 firms for 2008 and on average for the past five years. Nor are there excessive returns to shareholders. Returns on invested capital for broadband suppliers are well below the S&P average for 2008 and on average for the last five years. Reregulators often claim that broadband providers ration or suppress investment as means of holding up profits, yet these data make clear that broadband providers are ploughing back over 60% of cash flow from operations into capital expenditures. That is well above the average from our sample of S&P 500 companies. The two largest broadband network builders and investors in 2008 (VZ and T) combined for about five times the amount provided to NTIA and RUS in the broadband stimulus package.

Creating and saving jobs? The data in the table also indicate the role of broadband network providers’ investment in creating and saving jobs. Both use substantially more labor for dollar of output than the S&P average. Thus, a shift of revenue to the broadband provider sector from others will create more jobs, which of course is an important objective of the Congressional economic and broadband stimulus package. But, we have not been able to find economic evidence of conduct or performance measures that suggest market failure or signal what kinds of regulations might improve broadband performance.

We conclude by soundly declaring that the foregoing provides no basis that the current market structure is an indicator of market failure nor does it support a return to common carrier regulation of the broadband network supply. The FCC Notice of Inquiry In the Matter of Broadband Industry practices characterized the broadband market as showing “ever increasing intermodal competition among broadband providers.” We have found nothing of consequence to support a case for common carrier regulation based on market structure, nor on international comparisons, nor on two or three instances of market conduct. Commonsense suggests that it must be based on a thorough consumer welfare oriented cost-benefit analysis of the conduct and performance of markets and of the well known infirmities of government efforts to manage competitive processes.

It is important for the Commission to take due notice of, and to factor into its construction of a national broadband policy, the fact that policies that maximize the number of competitors are not necessarily congruent with policies that will lead to greater willingness and ability, or otherwise incent firms, to investment. The reasons are well known and related to the relationships between the burden of fixed costs, optimal scale, size of the market, and the number of competitors sustainable in the long run. Where there are substantial economies of scale (that is where minimum efficient firm size is large relative to the size of the market), where fixed costs are a substantial part of total cost: and, where marginal cost are low and below average cost, government can have very little impact on the number of competitors. Its role is limited to permitting as many as feasible and being a watchdog but it cannot force long term existence of more competitors than dictated by the relationship between the size of the market and the structure of cost. With respect to the number and concentration of sellers, markets trump regulation. While consumers are in general made better off with more choice, it does not follow that government attempts to force increases in the number of options may increase welfare in instances where the economics of cost and demand warrant otherwise.

In summary, increasing investment and stimulating competition by increasing the number of rival providers in the marketplace are worthy policy goals — but they can be conflicting goals. Because fixed and sunk costs needed to offer broadband access are substantial, public policies aimed at increasing the number of providers of retail broadband network services will not drive broadband speeds up or drive prices down in markets. Therefore, notwithstanding wishful thinking and claims to the contrary, merely increasing the number of rivals and choices available to consumers will not bring about improved broadband performance.

VII. FAILURE OF ADVOCATES TO DEFINE AN ENFORCEABLE DEFINITION OF DISCRIMINATION

In our initial comments, we emphasized and documented fully that price discrimination is ubiquitous in the economy and among other firms in the Internet value cluster (providers of applications, software, providers, equipment suppliers); that it is a common element of competitive market conduct; that it has been encouraged historically by the FCC in its pursuit of universal voice service; and, with some limited exceptions, a practice that invariably increases consumer welfare.

Based on a) our perceptions of the lack of clarity and inapplicability of the Commission’s past efforts to enforce the requirements of Section 201 and 202 of the Communications Act and b) our doubt that the advocates of nondiscrimination would be able to devise a workable definition, we made clear the consumer welfare basis for our preference that the Commission not undertake to regulate rates on the basis of whether they are or are not discriminatory. We urged the Commission to insist that proponents provide a clear, readily enforceable definition that separated acceptable from unacceptable market behavior. Doing so is absolutely critical to prevent regulatory delay, uncertainty, and the burden of other unanticipated costs from discouraging efficient resource allocation, positive investment signals and rapid movement toward the goal of universal access.

Several respondents reiterated their insistence on previous occasions that the Commission impose rate regulations on access providers and in particular evaluate all rates according to a standard of nondiscrimination. Some advocates did not even attempt a definition. None came close to recommending a clear cut standard that would assure minimization of regulatory uncertainty and unanticipated regulatory costs. And, some were downright confusing and merely highlighted the difficulty of meeting the standard set forth by Commissioner Copps: “a specific principle of enforceable non-discrimination, one that allows for reasonable network management but makes clear that broadband network providers will not be allowed to shackle the promise of the Internet in its adolescence.” Such a standard is necessary to provide clear regulatory signals to suppliers and users alike as means of avoiding regulatory delay, uncertainty, risk and the suppression of investment incentives necessary to achieve the universal broadband access goal.

The Commission must insist on definitions that clearly divide acceptable from unacceptable conduct and that are enforceable. Failure to do so is assured to create enormous uncertainty in financial markets, delay investment decisions and suppress network growth. Moreover, aside from the economic effects, failure to define terms that are instrumental in the enforcement of rules governing market conduct and the use of private property renders any Commission decisions on key broadband policy matters vulnerable to reversal on grounds that they are “arbitrary and capricious.” To illustrate, cite the vague directions in the Google filing and others. Likewise, the Free Press definition is neither clear, adequate as to what is or is not permitted, nor defensible as a basis for dramatic reversals in public policy.

The danger here is that the Commission will adopt as a major driver or element or characterization of its overall policy (objective) some vague notion that is not clearly defined, then rationalize regulatory constraints and obligations on that basis. An analogy might be the enforcement of a rule that permits only honest and beautiful women and handsome men to vote in the absence of any further specification of what those terms mean.

VIII. WIRELESS MARKET PERFORMANCE REFLECTS EFFECTIVE COMPETITION
In addition to the universal support for more investment, respondents to the Commission’s Notice also agree generally on the value of measures that will lead to more consumer choice and market rivalry. No single prospect for enhanced broadband competition is more likely or important than increased investment that would enable and expedite the emergence of advanced wireless networks. Such networks would provide a third broadband facilities based path to most U.S. households and for some hard to serve and unserved areas the first and only path.

Wireless networks are quite capital intensive, but substantially less so than wireline networks. Building them out to accommodate demand growth and upgrading them to provider more bandwidth to users will require favorable access to both capital markets and to public spectrum. As with wireline networks more generally it is imperative that the National Broadband Policy reflect a keen awareness and sensitivity to the negative impact of well intended government regulations on the ability of firms to invest and the willingness of capital markets to provide the wherewithal. Comments of several parties who advocate a diverse array of regulations under the broad umbrella of “wireless network neutrality,” “openness,” “open networks,” “wireless Carterfone,” or some other abstract basis notably exclude such concerns and considerations.

Notwithstanding the broad consensus that the U.S. leads the rest of the world (across the board using a variety of metrics) with respect to wireless performance and that the level of competition in the wireless sector is a model for the rest of the world, the Reregulators, stripped of the “We are behind the rest of the World” rationale for regulation, nevertheless urge draconian measures to “foster greater competition among service providers.” And, this without regard or reference to either the current level of performance documented by publicly available data and of competent analysis. All reasonable indications from these indicate laudable performance in the sector, as measured by the rate of handset and network innovation, the rate of investment, the downward trend in rates, penetration, usage growth, service quality and other common indicia of consumer welfare. The plea for more regulation appears to be largely a matter of “regulation for regulations sake.”

If the standard for comparison is the textbook model of perfect competition or a close facsimile thereof, economists and informed policy analysts generally agree that market failure is the universal rule. Comments of the following sort are strewn plentifully through the literature on regulation and economic welfare:
A fundamental problem with the concept of market failure, as economists occasionally recognize, is that it describes a situation that exists everywhere…an analyst in search of externalities and market failure can find them anywhere, [and thereby provide] a universal justification for any sort of government intervention that he or she might want to promote.” Thus, “Market failure simply means the failure of real world markets to achieve the standards of imaginary markets.”

Some markets do of course fail and all are imperfect, but the required proof of failure and the companion assertion of the desirability of government intervention are not satisfied by mere citation of such truisms. What is required is, as emphasized in our initial comments, and above, are data and analysis of consumer welfare impacts showing that the costs of regulation do not exceed the benefits asserted.

The original, and what appears still to be the principal, basis for the notion of applying Carterfone interconnection principles to wireless providers is a paper by Law Professor Timothy Wu. The proposal would apply a regulatory regime fashioned specifically for a regulated monopolist, protected from competition by regulatory barriers to entry, and using circuit switched wireline technology to provide largely dial up voices services. None of those facts apply to current wireless networks and each is material to assessing the costs and benefits of regulation. None of the differences are even acknowledged, much less evaluated as to their impact, by advocates of applying the scheme to wireless providers. The Wu proposal has been soundly rebutted on the basis of fact, economic principles, applied engineering and common sense.

The case for imposing the full network interconnection regime associated with Carterfone and common carrier style regulation of wireless networks is based largely on uncritical assumptions that imposition of administrative constraints on imperfect market processes is costless, or practically so, and that market performance is not significantly diminished thereby. Just stating, explicitly that implicit assumption should serve to highlight its folly. A fair evaluation of the need for regulation requires comparison of the performance of markets with and without certain government actions – in particular economic regulations imposed by FCC and state bodies. This in turn requires assessment of the performance of government actions that constrain – compel or prevent – private market conduct.

Government intervention is not justified by simply calling attention to market imperfections, especially when the companion interventions themselves occasion significant costs as they do here. There is no such thing as a free regulation—one whose benefits are not accompanied by cost imposed in other terms, on other economic actors, either currently and/or in the future. The public interest standard can stand for many things, be variously defined and be interpreted in numerous ways. However, the standard is surely not satisfied by government actions taken on the basis of conjectural at best and largely undefined benefits without regard to costs.

IX. CONCLUSION

In our initial comments we emphasized the importance of evidence, analysis and a consumer welfare perspective in the Commission’s National Broadband Plan.

Much of the foregoing has addressed comments of parties who share a common goal of reversing more than a decade of precedents and decisions that have rebalanced reliance on markets and government regulation. Our review of the positions, claims of market failure and scant data offered by these parties concludes with the Scotch Verdict: “Case not Proven!”

The Commission should place a heavy burden on those who argue for a return to regulatory regimes that have been incrementally on the basis of strong evidentiary records open to all points of view and not, as implicated by some critics, haphazardly and carelessly by rogue Commissions. FCC decisions leading to less regulation and greater reliance on markets – the phasing out of common carrier restrictions – have spanned different political administrations; have frequently been adopted by unanimous votes of a succession of Commissions; have had broad bipartisan support in Congress; and, last but by no means least important, have passed judicial review for consistency with governing statutes and the intent of Congress. It is notable in this context that there is a substantial amount of evidence and political support for the opposite criticism; namely, that the Commission has not moved quickly or far enough in the direction of greater reliance on markets and less on regulatory fiat.

Our view about the inadequacy of the case put forth or reregulating information networks does not reflect across the board hostility to regulation in general. We emphasize again our recognition of affirmative roles for government in advancing consumer welfare and support for well conceived and execute consumer protection initiatives related to privacy protection, assurance that consumers are fully and accurately informed about rates and other conditions attached to the services from which they choose. We have also opposed on numerous occasions efforts by vertically integrated firms to leverage strengths in some markets to favor competitive services they do or might provide in others. Thus, where there are clear and measurable welfare benefits of regulation in excess of related costs, we do and will support government intervention. Simply put, that is not the case here.

The brief of the Reregulators appears to agree that a necessary element of a National Broadband Policy is universal access and, by logical inference, high levels of investment in broadband network facilities. We cannot confidently estimate the total amount of new capital formation required to migrate existing network facilities from where we are to a reasonable notion of universal access. There is no disagreement though, that hundreds of billions will be required to address “most” households with “fast” Internet connections. Some suggest that government should build the networks, but current fiscal realities offer no reasonable prospect for that in the near term.

Nowhere in the case for regulation is there any link between the policies recommended and the impact on new capital formation. Reregulation will almost certainly reduce business opportunities and options of operators; increase their capital and operating costs; increase their uncertainty about future business prospects; increase delay in their ability to respond to technological and economic dynamism of broadband markets; chill capital market views of the merits of providing risk capital; and, cause capital budgeting managers of broadband providers to consider other options. That much is known and a part of the record, but not addressed in the brief for reregulation. The burden is on Reregulators to show how their proposals for more government controls will lead to faster rates of capital formation. In that respect we note the absence of a scintilla of evidence, or even discussion, of how such things as net neutrality, open networks, end-to-end networks or any of the other euphemisms for reregulation would lead to superior progress toward the goal of universal access to broadband networks and higher rates of capital formation.

It is worth noting here that during the old common carrier regulatory regime, firms were induced to invest by protection from competition by regulatory barriers to entry and by cost plus, rate of return regulation that virtually assured investor returns commensurate with associated risk. Government cannot force firms to invest in broadband facilities. Government must provide incentives for them to do so. The Reregulatory brief moves in the opposite direction.