Economics and Technology, Inc. -- Views and News, July 2010

July 2010

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FCC denial of Qwest's Phoenix Forbearance Petition highlights new focus on carrier market power

Earlier this summer the FCC released what many hope is a precedent-setting Order denying a Qwest Petition for regulatory forbearance from most of the Commission’s remaining Title II regulations in the Phoenix metropolitan statistical area (MSA). This was Qwest’s second attempt at gaining full deregulation in Phoenix and for the second time it was unable to make a viable case for deregulation. More noteworthy than the Commission’s rejection of what can most charitably be described as an over-aggressive deregulatory Petition was the FCC’s analysis underlying the denial: the June 22, 2010 Qwest Phoenix II Order represents a dramatic departure from the competitive analyses the FCC has been employing for the last decade. Earlier forbearance rulings had been premised upon a theoretical and factual foundation that “predicted” competitive growth, drawing upon anecdotal competitive evidence, rather than any formal quantitative analysis of the carrier’s market power. In the Qwest Phoenix II Order, however, the FCC has now laid out and applied an antitrust type of “analytical framework” involving a comprehensive market power analysis with a strong emphasis upon market definition, market share, and other quantitative indicia of actual competition. This rigorous approach can be expected to form the basis for review of future ILEC Forbearance Petitions as well as for other regulatory reviews – most notably the FCC’s ongoing Special Access investigation.

Shoring up prior Orders denying forbearance

In crafting the Qwest Phoenix II Order, the FCC was clearly mindful of the outstanding DC Circuit Court of Appeals remand of its earlier denials of Verizon’s Forbearance Petitions for broad deregulation in six MSAs (Boston, Providence, Philadelphia, Pittsburgh, Baltimore and Norfolk/Virginia Beach) and Qwest’s original Petition for Forbearance in four MSAs (including Phoenix as well as Minneapolis, Denver and Seattle). The Court had questioned why the FCC had not evaluated the impact of “potential competition” (the market disciplining effect that the threat of competitive entry would have upon a service provider) in the Verizon and Qwest MSAs (a criterion it had employed in approving earlier Forbearance Petitions in Omaha, Anchorage and Terry, Montana), and remanded the decisions back to the FCC on that narrow issue. In the Qwest Phoenix II Order, the FCC addresses the issue of potential competition head-on, finding that in order for “potential competition” to reduce an incumbent’s market power the “potential” needs to have a realistic and probable basis.

Using a supply-side analysis of the ability of competitors to respond to Qwest throughout the Phoenix MSA, the FCC concluded that “potential competition” did not diminish Qwest’s market power in the Phoenix MSA and that earlier FCC decisions that had included the impact of “potential competition” substituted “predictions” of future competition for a rigorous analysis of the “potential” for competition, noting that the Qwest Phoenix II Order corrects that error. It would be surprising if this same quantitative justification does not form the basis for analysis in the outstanding remand orders in response to the DC Circuit Court of Appeals.

Repudiation of the careless results-driven deregulatory decision-making of the past

In some of its earlier forbearance and other deregulatory orders, the FCC mixed and matched market evidence from the enterprise and residential, retail and wholesale markets (just as the carriers requesting the elimination of regulatory constraints had done in their filings), only nominally defining separate product markets. Using the analytical framework it now lays out, the Commission here separately examines each of the various product markets (enterprise and residential, retail and wholesale), and concludes that effective competition does not exist in any of them in Phoenix.

The FCC also openly criticizes some of its own earlier prediction-driven deregulatory decisions. In a discussion of the ILECs’ failure to continue to provide competitors with wholesale inputs at fair and reasonable prices (after the Commission had forborne from requiring them to do so), the Commission now concedes that this result should not have been surprising, noting that “assuming that Qwest is profit-maximizing, we would expect it to exploit its monopoly position as a wholesaler and charge supracompetitive rates, especially given that (absent regulation) Qwest may have the incentive to foreclose competitors from the market altogether.”

Renewed recognition of the importance of wholesale markets for enterprise services

The FCC’s analysis of the enterprise services product market placed particular emphasis upon competition at the wholesale level. Examination of the data filed by a variety of parties in the proceeding led to a finding that wholesale competition for the kinds of services utilized by enterprise (large business) customers is almost nonexistent. The finding of a lack of competitive alternatives at the wholesale level is of particular importance here because, in addition to its adoption of a quantitative analysis, the FCC re-embraces its earlier interpretation of the 1996 federal Telecommunications Act as supporting the development of local competition through both facilities- and non-facilities-based entry.

To emphasize its findings that competitors rely upon Qwest’s wholesale services to compete, the FCC quotes extensively from orders that pre-date the Powell/Martin Commission, in which the FCC had identified formidable entry barriers. The Commission reinforces its theoretical analysis with empirical findings regarding the status of competition, including the finding that even the largest CLECs rely upon ILEC last-mile facilities to connect to the vast majority of their enterprise customers; that ILECs have not continued to provide competitors with wholesale inputs at fair and reasonable prices; and that intermodal competitive services (such as fixed microwave for enterprise customers) have not emerged or are not available to near the level necessary to constrain the ILECs’ market power.

Use of the Qwest Phoenix II Order “analytical framework” in ongoing and future FCC proceedings

In a concurrently issued Public Notice, the FCC has indicated its intention to apply the same “analytical framework” to other forbearance proceedings. Not specifically addressed is the range of ongoing and future proceedings in which the FCC is examining the status of competition and the consequences of its deregulatory policies of the past decade, such as its long-running Special Access Investigation (CC Docket No. 05-25). ETI’s own Dr. Lee Selwyn, invited by the FCC to participate at an “economists workshop” on the appropriate “analytical framework” to use in evaluating the speical access market on behalf of large enterprise customers, members of the Ad Hoc Telecommunications Users Committee, recommended that the Qwest Phoenix framework be directly applied to special access.

A wide range of findings with far reaching implications

Many of the Qwest Phoenix II Order’s findings relative to market power and competition clearly have implications far wider than the Phoenix MSA. Of particular note, the FCC found that the expansion of facilities by cable companies to mass market customers is not predictive of new entry by other competitors that lack cable’s existing infrastructure platform, thus supporting a conclusion that a “duopoly” market structure is likely for many local telecom markets. Further, the FCC also found that “[t]he move from monopoly to duopoly is not alone necessarily sufficient to justify forbearance” and “economic theory holds that firms operating in a market with two or a few firms (i.e., an oligopoly) are likely to recognize their mutual interdependence and, unless certain conditions are met, in many cases may engage in strategic behavior, resulting in prices above competitive levels.” It would seem that the FCC now understands that there is indeed a continued role for regulation.

If you would like more information on this subject, please contact Susan M. Gately.

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