Although the Department of Justice Antitrust Division (DOJ) has not confirmed it, the Wall St. Journal reported that DOJ is internally considering whether or not companies “such as AT&T and Verizon” have abused their market power. Most traditional antitrust lawyers I've seen quoted don't think it likely the telcos have market power — especially given the hostility that courts have recently shown to antitrust. Indeed, in a world where even potential competition is supposed to be part of the market analysis, how can a modest 60% of the wireless market shared by the two companies, with no evidence of price fixing or coordinated behavior, support any sort of antitrust action?
Welcome to the more grown up and sophisticated view of market power in the more complex real world. After more than 25 years, U.S. antitrust authorities may be ready to reexamine the underlying limitations of antitrust in light of a new generation of economic scholarship on the subject of market power and the exercise thereof.
The core of current antitrust analysis goes back to 1982, when the DOJ and FTC adopted the <a href=http://www.usdoj.gov/atr/public/testimony/hhi.htm”>Herfendahl-Hirschman Index (HHI) as the cornerstone of antitrust enforcement. As explained in the 1992 Horizontal Merger Guidelines, HHI measures “horizontal concentration” for a specific product market and geographic market. Taking ten competing firms as the competitive nirvana, and four equal-sized firms as “mildly concentrated,” the HHI assumes that companies must have a huge percentage of the market (“market share”) to exercise any sort of power over pricing or terms, otherwise people will switch from one provider to another.
As time went on, and the policy world became ever more “free market” (meaning “deregulated” not “competitive”), courts and regulatory agencies weakened this analysis further. The Bells system reconstituted by narrowing the geographic scope of the analysis so that it became “local monopoly + local monopoly = no change in concentration and ignored the national market.” Product markets were defined narrowly to make them more competitive, and “potential” anticompetitive impacts might be offset by “synergies” and other “pro-consumer benefits.” At last, even the potential for competition became enough to undermine the evidence of existing market share.
But while Washington D.C. remained frozen, economic theory evolved. The concept of network effect not even formally defined until 1985 in papers by Farrell & Soloner and (separately) Katz and Shapiro has increasingly shaped economic study as networks have become ubiquitous and the power of network effects and switching costs to lock in customers and enhance market power have increased exponentially. The use of interlinked networks for a variety of commercial markets of potentially unlimited geographic scope has also created more complex market structures than the simple geographic market/product market paradigm employed by the HHI and — by extension — the DOJ, FTC and the courts.
The infusion of a new generation of antitrust enforcers, schooled in the new economics and witnesses to the increasing failure of the traditional HHI-based antitrust paradigm, may well see things very differently than the traditional antitrust bar. Empirical evidence all points to the ability to raise prices and shut out competitors with market share significantly lower than that considered highly concentrated by HHI standards. But whereas the previous generation dismissed such contradictions with approved University of Chicago orthodoxy with the same vigor as the Catholic Church suppressing Copernicus in favor of Ptolmey, the new generation applies a different framework. Network effects and switching costs can create lock-in that allows the exercise of market power at much lower levels of concentration, because these things make it much harder for customers to switch. The ability to surpress needed market information through non-disclosure agreements likewise allows for the exercise of market power by limiting choice. Vertical integration may confer significant advantages, particularly in complex markets.
For example, a competing wireless carrier might pay AT&T for roaming and for backhaul from its cell towers in the same market, two expenses AT&T will not incur for its own wireless service. The competing carrier will have no way to determine whether AT&T has charged it a fair price for either service, since the ubiquitous use of non-disclosure agreements prevents it from comparing the prices it pays with the prices AT&T charges others. At the same time, AT&T may limit the availability of desirable handsets because the millions of customers it does control provide it with an attractive enough customer base to demand an exclusive as a condition of reaching its customers at all. This exercise of market power further weakens the competitive position of the would be rival, which must pay higher prices for less attractive equipment.
Mind you, at this stage, everything is extremely tentative. While economics might characterize these market impacts as “market power” or “monopoly/monopsony rents,” it is not at all clear that the D.C. Circuit will accept a new theory of antitrust enforcement any time soon. Nor is it even clear that the the DOJ or FTC will chose to pursue these new antitrust paradigms through enforcement action. Although the DOJ has no rulemaking authority (and FTC is barred from regulating common carriers), the agencies may use this investigation (and others, such as the investigation into Google's connection with Apple) to issue policy statements that would set the course for future enforcement action. Or this might just fizzle out on its own.
But for now, I applaud the DOJ apparently making good on Christine Varney's pledge to reinvigorate antitrust and her recognition of how important antitrust enforcement is to the digital economy. And if traditional antitrust lawyers find this difficult to swallow, I advise them to consider that there are perhaps more things in economics and in antitrust than are dreamt of in their jurisprudence.