November 1, 2016    12 minute read

Regulation Of Market Power In The US Internet Sector

Anti Trust Laws    November 1, 2016    12 minute read

Regulation Of Market Power In The US Internet Sector

US Antitrust Law

In general, Antitrust Law is a set of regulations that aims to preserve competition to increase consumers’ welfare. Nonetheless, there are some slight differences in antitrust law among states and countries. In particular, the primary aim of US antitrust law is to protect the interest of consumers rather than protecting the market structure (as it happens in the EU). This means that in the US, a behaviour distorting competition may be ruled lawful if the benefits that it offers to consumers outweigh the harm to competition.

Market Power

In US antitrust law, the term “Market Power” is essentially a synonym of “Monopoly Power” which is by definition of the Supreme Court “the power to control prices or exclude competition”. In practice, this means that a firm holding Monopoly Power can increase prices above the competition level thus harming consumers. To clarify, a company controlling most of the market can increase prices as it faces no competition and thus consumers will be damaged because they are consequently forced to pay more.

Section II Of The Sherman Act

In the US, Monopoly Power is regulated by Section II of the Sherman Act which requires two conditions for a behaviour to be considered illegal:

  1. The possession or the attempt to possess a monopoly power in the relevant market
  2. A unilateral conduct that limits competition on that market

In practice, holding a monopoly power without imposing any restriction to competition and trade is perfectly legal, whereas the combination of monopoly power and restriction to competition is illegal and it is sanctioned by Section two of the Sherman Act.

Assessing Monopoly Power In The US

In the US monopoly power is conventionally defined when:

  1. The company has (or has the probability to obtain) a high market share and
  2. There are high entry barriers in the market

However, in practice, antitrust agencies and in particular the US Department of Justice use a specific tool to measure the level of competition on the market, to assess whether a company holds monopoly power or not and whether a merger is a threat to competition or not. This measure is called Herfindahl-Hirschman Index (HHI), a very easy-to-calculate index, which is the sum of the squared market share of each firm in a market. It can range from close to 0 (when each firm has a very low market share) to 10,000 (when a firm holds 100% of the market i.e. 1002 = 10.000).

In particular, the considerations of the U.S. Department of Justice about the HHI Index are the following:

  1. Competitive market: HHI < 1,500
  2. Moderately concentrated market: 1,500 < HHI < 2,500
  3. Highly concentrated market: HHI > 2,500

In addition to this, mergers that increase the HHI by more than 200 points in highly concentrated markets capture the attention of the agencies as they should increase significantly the market’s concentration.

Internet Sector (ISPs)

Having assessed the notion of market power and the regulation concerning it, the last element to define before starting the analysis is the internet sector. In particular, we shall focus on the Internet Service Providers (ISPs), i.e. companies that provide access to the internet to consumer and businesses. ISPs can offer different services e.g. information service provision, being an Internet Network Service Provider (INSP), or being a storage service provider or a combination of the three.

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Figure 1: The Structure Of The ISP Industry

As illustrated in Figure 1 below, ISP’s such as Verizon or Comcast allow private users (consumers and companies) to connect to internet servers like google.com, facebook.com and communicate with other private users (for example via e-mail). The whole process is possible thanks to internet backbone, the leading wire to which both servers and individual users are connected.

The internet sector is continuously changing and growing at an incredibly high rate. This growth represents a real challenge for regulators to ensure the respect of Antitrust Laws and the maintenance of consumers’ welfare.

Analysis Of ISP Market Power In The US

To understand the market power in the Internet sector, ISP’s must be able to breakdown into cable companies i.e. the ones who offer access to the internet via cable and phone companies – the ones who offer mobile internet access.

Concerning cable companies, as seen from the graph below, (Figure 2), the industry is highly concentrated with two companies (Comcast and Charted) holding together 80% of the total market share. As a consequence of this, 4/5 of US citizens have only two choices for their cable internet provider.

80% Market share of Comcast and Charted in US

With regards to the phone companies offering broadband internet access (Figure 3), the situation is slightly different, as here there are four major companies (AT&T, Verizon, CenturyLink and Frontier^) controlling 96% of the market. However, AT&T controls 45% alone and towers over rivals in the sector since Verizon, CenturyLink and Frontier^ possess 20%, 17% and 13% of the market respectively.

Figure 2: Cable Company Industry Market Share, Figure 3: Phone Company Cable Company Industry Market Share

The percentages represent the number of subscribers.

At a first look, one might think that the oligopoly in the phone ISP is due to the monopoly power hold by cable companies which charge high prices to use their connections. However, the reason behind this oligopoly can be found the US government laws. Indeed, to build new networks, IPSs have to both obtain pole attachments and negotiate with local governments to obtain the permission to place their wires above and below both public and private property. The result of this negotiation is that local governments can charge ISPs with extremely high prices (as high as the total cost for the network construction).

Local Governments Decide Barriers

Therefore, only big companies like AT&T and Verizon can afford such a large investment. As a consequence of this, broadband has had troubles in expanding in the US. In addition to this, local governments also have the power to decide to lower these high barriers for certain competitors rather than for others. This has happened for example in Texas in the cities of Austin, Provo and Kansas City, where because the government strongly wanted Google Fiber, it gave Google access for a very low cost. Clearly, this situation of concentrated markets is in fact due to the excessive power concentrated in the hands of the local governments rather than the power in the hands of the competitors in the internet sector. This could explain why Antitrust authorities have done little or nothing to stop this abuse and have limited room to manoeuvre an end to this situation. The only solution should be that local governments start to grant open access to their rights-of-way in order to open the access to the broadband market also to smaller competitors.

Zones Of Dominance

Finally, by combining the data of the phone and of the cable industries (Figure 3), it can be observed that the Broadband sector is dominated by three main companies: Comcast 26%, Charted 24% and AT&T 17%. Then, another 30% of market share is spread among five companies holding more or less the same share.

From a competitive point of view, the combined picture (cable and phone) does not seem to be a too highly concentrated market with respect to the two former disaggregated pictures. One may say that this is not a good proxy for the reality as most of the time cable connection and phone connection have their own “zone of dominance”. In other words, often US citizens have only two choices for the cable connection and only two choices for the phone one. In fact, the data in the graph are aggregated data, in reality some states are dominated by some companies whereas other by different ones.

However, internet phone services are becoming more and more substitutable for cable services. The fact that 40% of the total market share is dominated by phone companies (AT&T, Verizon, CenturyLink, Windstream, Frontier and others) whereas 60% is dominated by cable ones (Comcast, Verizon, Altice and others) is a very positive thing for consumers. These consumers face more choice for their Internet providers in that they can be cable or phone based providers.

Broadband internet providers

Figure 4: Broadband Internet Provider Market Share Breakdown

Thanks to the theoretical guidance and the HHI index I will try to derive some conclusion on the level of competition in the internet sector in the US.

The HHI index for the cable industry is calculated as follows using the data in the graph: 422(Comcast) + 382(Charter) + 72(Altice) + 22(Mediacom) + 12(WOW) + 12(Cable ONE) +… = 3,263 * **

*the result will not significantly change by adding all the small competitors since the square of a number < 1 is always <1

**the 9% controlled by others has not been added since the market share of these companies was <1%

The HHI index for the phone industry is 2,894.

The HHI for the combined cable and phone broadband providers is 1,697.

Therefore, simplistically, both the cable and the phone internet providers’ industries are highly concentrated, whereas the combination of the two is only moderately concentrated.

Concerning acquisitions, in the first quarter of 2016 of Time Warner Cable was acquired by Charter Communications. Time Warner had 13,640,000 subscribers which accounted for 24% of the total market share whereas Charted had 11% of market share. This acquisition has increased the HHI index by approximately 850 points, and the Department of Justice has announced that it will approve the acquisition under the sole condition that it will not restrict competition in the Video Distributor market. Unofficial reasons behind this decision are that, first of all, there is no favourable argument (with the exception of the video distribution) that this acquisition will trigger a loss of competition. Indeed, Charter after the acquisition is almost as big as Comcast, and thus it will be a valid alternative for consumers as it will contrast the Comcast domain. In addition to this, the growth of Charter will be able to distinguish the threat of large phone companies such as AT&T and Verizon which are gaining market power as they can offer value based offers without requiring annual contracts.

Conclusion

In general, as seen in Figure 3, thanks to the presence of large businesses in both the cable and in the phone sectors, the broad picture of cable companies plus phone companies results in a non-high-concentrated market where large phone companies (AT&T and Verizon) can contrast large cable companies (Comcast and Charter) in an efficient and well-balanced way.

Therefore, the US Antitrust Authorities do not seem to need to intervene much in the internet sector, because, contrary to what would appear at first glance, it is not high-concentrated. The battle between the major cable providers and the major phone providers carries benefits for the consumers both regarding innovation and considering lower tariffs. Therefore, there is no reason to call for abuses of monopoly power punishable under Section 2 of the Sherman Act as consumers clearly benefit from this situation and there is no need to request the existence of a monopoly since cable ISPs and phone ISPs are going to be more and more substitutable for consumers (thanks to free Wi-Fi, 4G, etc.). However, to ensure higher benefit for consumers, in 2015 the FCC has adopted new sustainable rules that apply to both fixed and mobile broadband providers.

These rules are:

  1. No blocking: broadband providers may not block access to legal content, applications, services, or non-harmful devices.
  2. No throttling: broadband providers may not impair or degrade lawful Internet traffic by content, applications, services, or non-harmful devices.
  3. No paid prioritisation: broadband providers may not favour some legitimate Internet traffic over other lawful traffic in exchange for consideration of any kind—in other words, no “fast lanes.”  This rule also bans ISPs from prioritizing content and services of their affiliates.

In practice, this means that ISPs cannot “unreasonably interfere with or unreasonably disadvantage” the ability of consumers to select, access, and use the lawful content, applications, services, or devices of their choosing.

In addition to this, the new rules require that broadband providers disclose, in a consistent format, promotional rates, fees and surcharges and data capacities. Disclosures must also include measures of network performance for consumers to be able to make good choices. This new ruling also takes into account the difficulties faced by small ISPs, by giving a temporary exemption from the transparency enhancements for fixed and mobile providers with 100,000 or fewer subscribers.

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