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UNITED STATES v. WESTERN ELEC. CO.

July 25, 1991

UNITED STATES OF AMERICA, Plaintiff,
v.
WESTERN ELECTRIC COMPANY, INC., et al., Defendants


Harold H. Greene, United States District Judge.


The opinion of the court was delivered by: GREENE

The issue before the Court in this, the most recent chapter of this antitrust case, is whether the Court should remove the restriction on information services imposed as part of the consent decree. Under a decision of the Court of Appeals, such removal is required if this Court is not able to conclude from the evidence that the entry of the Regional Companies into the presently restricted market would be certain to lessen competition.

 I

 History

 This lawsuit was brought by the Department of Justice on behalf of the United States against the American Telephone and Telegraph Company in November 1974. Following a period of discovery and of pretrial motions, an eleven-month trial began in January 1981. See generally, United States v. American Tel. & Tel. Co., 552 F. Supp. 131 (D.D.C. 1982), affirmed sub nom. Maryland v. United States, 460 U.S. 1001, 75 L. Ed. 2d 472, 103 S. Ct. 1240 (1983). Shortly before the taking of evidence was to be concluded, the parties agreed upon and submitted to the Court a proposed consent decree.

 The Court held extensive Tunney Act *fn1" proceedings, in which all organizations, private and public (including twenty-nine States), with an interest in the decree were permitted to intervene and to participate. The Court approved the decree with some modifications on August 24, 1982, and entered it on that date as a final judgment. The Supreme Court affirmed that judgment on February 28, 1983. *fn2"

 The seven Regional Companies, *fn3" which had inherited all the local telephone companies of the Bell System at the time the System's assets were split up, were subjected under the terms of the decree to several restrictions. These restrictions were based upon the kinds of anticompetitive activities that the local companies had engaged in while they were still a part of the Bell System, or were likely to engage in because the ability and the incentive therefor were present. As here relevant, one of the provisions of the decree prohibits the Regional Companies from providing interexchange and "information services," *fn4" such services being defined as follows:

 
"Information service" means the offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information which may be conveyed via telecommunications, except that such service does not include any use of any such capability for the management, control, or operation of a telecommunications system or the management of a telecommunications service.

 552 F. Supp. at 229.

 In 1987, in response to an initiative of the Department of Justice, the Court conducted a so-called triennial review of the continuing need for the restrictions imposed by the decree. At that time, again, the Court permitted wide participation in and intervention by interested parties, both private and governmental.

 Following that review, the Court removed the restriction on the transmission of information, as well as a comprehensive catch-all restriction on the entry of the Regional Companies into non-telecommunications markets. However, the Court concluded that there was no basis for removing the three "core" restrictions -- those on interexchange services, the generation of information, and the manufacture of equipment. See generally, United States v. Western Electric Co., 673 F. Supp. 525 (D.D.C. 1987).

 The Regional Companies and several other parties, including the Department of Justice, took appeals. The Court of Appeals affirmed the decisions of this Court on several issues, but it reversed and remanded the issue of information services. United States v. Western Electric Co., 283 U.S. App. D.C. 299, 900 F.2d 283 (D.C. Cir.), cert. denied sub nom. MCI Communications Corp. v. United States, 498 U.S. 911, 112 L. Ed. 2d 238, 111 S. Ct. 283 (1990). The appellate tribunal held that, inasmuch as none of the original parties to the consent decree *fn5" is opposing the removal of the information services restriction, the appropriate provision of the decree to govern judicial decisions with respect thereto is section VII of that decree *fn6" (which, the appellate court said, establishes a public interest standard), rather than section VIII(C) *fn7" (which deals only with removals of restrictions contested by one of the original parties). *fn8" 900 F.2d at 295, 305-07.

 The Court of Appeals went on to indicate that, in view of the expertise of the Department of Justice in enforcing the antitrust laws, this Court was to defer to that Department with respect to a number of issues. *fn9" Inasmuch as this Court had in several respects applied legal standards differing from those laid down in the Court of Appeals opinion, the case was remanded for further fact-finding with respect to the information services restriction under the criteria established by the appellate court.

 Following the issuance of the appellate mandate, this Court once again entertained briefs from all the parties, including the intervenors which would be affected by the decision, and it heard oral argument during two successive days. In addition to their legal arguments, various parties and intervenors also submitted voluminous evidence in the form of affidavits and exhibits. *fn10" These affidavits, exhibits, and arguments form the basis for the instant decision.

 The Court will consider first the various aspects of the substantive issues *fn11" discussed by the parties to the proceeding.

 II

 Market Power

 The Court of Appeals has stated that the exercise of market power is a necessary prerequisite to damage to competition under the antitrust laws, and that "unless the entering BOC will have the ability to raise prices or restrict output in the market it seeks to enter, there can be no substantial possibility that it could use its monopoly power to 'impede competition.'" 900 F.2d at 296. The issue is whether the Regional Companies possess market power within the meaning of that definition.

 A. Market Power in General

 The Regional Companies note that market power is deemed to exist when there are substantial barriers to entry, a large market share, and a paucity of substitutes, and they contend most notably that they presently lack any market share in the information services market and therefore could not possibly have market power. Moreover, according to the affidavits and exhibits submitted by these companies, they could not hereafter obtain significant market share in competition with the many large companies already in the market, *fn12" and they would be unable in practice to raise their competitors' costs (through either higher tariffs or degraded access to the local exchange). Even if they could achieve such ends, the Regional Companies argue, they might at most be able to raise prices in the local exchange market, but not in the information services market -- the critical area for antitrust analysis according to the Court of Appeals.

 The most detailed evidence adduced by the Regional Companies on market power is an affidavit of Franklin Fisher, a professor of economics at the Massachusetts Institute of Technology. *fn13" According to Professor Fisher, the Regional Companies would be able to achieve market power only if (1) they had the ability to raise the costs of their rivals; (2) this ability gave them power over the price of information services; (3) regulators were unable to defeat this anticompetitive behavior; and (4) efficiency losses due to anticompetitive conduct by the Regional Companies outweighed the benefits to the public of the Regional Companies' presence in the market. *fn14" In this Part of this Opinion, the Court will examine only the first and second factors described by Professor Fisher; the third and fourth factors are discussed in Parts III and VI, respectively.

 Professor Fisher asserts in amplification of his conclusions that the information services market is national in scope, and that this fact permits independent information services providers to move their operations to the territory of a Regional Company that does not discriminate against them. *fn15" Moreover, according to the Fisher affidavit, the Regional Companies will not be able to discriminate at the consumer end of the telephone circuits because of the difficulty of acting selectively there, and the only way they could have power over price would be through collusion among all of them, which would be difficult to achieve inasmuch as seven different companies are involved. *fn16" Professor Jerry A. Hausman similarly contends that discrimination by a Regional Company would be inconsistent with market data and economic theory, in substantial part because the Regional Companies will compete against each other. *fn17"

 Other evidence submitted by the Regional Companies denies the existence of incentives to engage in anticompetitive acts. Thus, Dennis Carlton and George Stigler, both professors of economics at the University of Chicago, contend that the Regional Companies do not have an incentive to discriminate against competing information services providers because, if a competitor were driven out of business, the Regional Company would lose local exchange revenues from that competitor. *fn18"

 As concerns the Department of Justice, it submitted no additional affidavits or other evidence on this or any other issue in the remand proceedings, *fn19" with the exception of an appendix summarizing current regulations of the Federal Communications Commission. It may be regarded as odd that, on a remand for the specific purpose of the compilation of an evidentiary record, the Department produced no evidence whatever. *fn20"

 In the briefs it has filed in the current proceeding, the Department largely contents itself with supporting the arguments made by the Regional Companies. *fn21" But it is of more than academic or historical interest that, at the time of the adoption of the information services restriction, the Department postulated and persuaded the Court that the restriction was absolutely necessary, explaining as follows:

 
The firms that provide information services must rely on access to local exchange facilities under the ownership and control of the [Regional Companies]. As commenters such as the American Newspaper Publishers Association and the Association of Telephone Answering Exchanges point out, if the [Regional Companies] were permitted to offer information services they would have the power and the incentive to deter the development of competitive markets for these services. The Department, therefore, continues to believe that the [Regional Companies] must be precluded from engaging in such activities to ensure the development of competitive markets for information services. *fn22"

 The Department now states that it had concluded by 1987 that no substantial possibility existed that the Regional Companies could use their monopoly power in local exchange markets to impede competition in information services markets. However, that conclusion rests essentially only on the proposition that, in view of the decree's nondiscrimination provisions and of the present regulatory regime, it would be virtually impossible for a Regional Company to discriminate on a widespread basis without detection and sanction. *fn23" The issue of regulation is discussed in Part III, infra. Suffice it to say at this point that regulation was also present, albeit in a somewhat different form, when the Department unambiguously and vigorously called for a prohibition on Regional Company participation in the information services market.

 Regarding that aspect of its explanation which relies on the non-discrimination provisions of the decree, the Department notes that the degradation of calls to and from competing information service providers would be improper *fn24" under those provisions (as well as being difficult). The Department does not explain on what basis it may be assumed that, following the removal of the specific restriction on information services, the Court could reasonably convert the general antidiscrimination provisions of the decree into effective authority for restraining Regional Company anticompetitive action against independents with respect to information services, particularly since, on its face, those provisions prohibit only discrimination in favor of AT & T. *fn25"

 B. Market Power as a Consequence of Bottleneck Control

 Market power is often the consequence of sheer size or financial strength; but as the intervenors *fn26" point out, in the instance of the Regional Companies, their market power stems not from either of these factors *fn27" but from their still almost complete domination over the "last mile" of the telephone network, i.e., their monopoly of the local wires and switches without which few, if any, competitors can reach the ultimate consumers of telephone-based information services. In fact, around ninety-nine percent of the traffic to the ultimate subscriber must still pass, in the end, through the Regional Companies' local loops. *fn28"

 This basic circumstance *fn29" gives these companies the ability to exercise market power *fn30" with respect to the information services markets, that is, to raise price, to restrict output, or both. The Regional Companies would be able to raise price by increasing their competitors' costs, and they could raise such costs by virtue of the dependence of their rivals' information services on local network access. As Professor Hall states, "when all but one firm in a market have higher costs, the inevitable result is a higher price, lower output, and lower consumer welfare." *fn31" Similarly, a Regional Company would be capable of discouraging entry by acquiring a reputation for strategic predatory pricing and denying its competitors post-entry profits, *fn32" and it would be able to do so credibly because it could shift the costs of its information services to its regulated operations. *fn33"

 The Court is further of the view that, if relieved of the restriction, the Regional Companies would carry out these strategies because (1) this was the pattern of their operations when they were a part of the Bell System, and (2) even after the break-up of that System, they have been engaging in these practices to the extent that they have been permitted into markets that offered opportunities therefor. See Part IV, infra.

 The evidence *fn34" also demonstrates that non-telephone-based services are not substitutes for the information transmitted over the telephone network, if only because the basic telecommunications network has distinct properties not available through other means: only the telecommunications network can offer two-way interaction with up-to-the-minute information databases accessible by a large customer base, including occasional users. *fn35" Clearly, telephone-based information services constitute a market that is separate from services delivered by other means. *fn36"

 What is notable in the papers submitted on this issue by the Regional Companies is what is not discussed or discussed only to a limited extent. In view of the centrality of the intervenors' argument that the Regional Companies have market power because of their control of the bottlenecks, *fn37" it might have been expected that the proponents of a removal of the information services restriction would first acknowledge the contention regarding that aspect of market power, and then attempt in some substantial way, by affidavits and otherwise, to answer it. Although half-hearted attempts are made to counter the intervenors' bottleneck point, recognition of the importance of the bottleneck issue is missing and so is a fully-developed, persuasive response.

 The Regional Companies do assert that "experience since divestiture, both at home and abroad, has demonstrated that control over the local telephone exchange is not a means to acquire market power in information services." *fn38" But there has of course been no experience with information services, for the Regional Companies have been forbidden since their birth to engage in such services (except for the limited purpose of transmitting information generated by others). See United States v. Western Electric Co., 714 F. Supp. 1, 5-7 (D.D.C. 1988).

 The Court permitted the Regional Companies to establish elaborate facilities and processes for the transmission of information generated by others precisely because it concluded that the "potential for anticompetitive behavior by the Regional Companies with respect to transmission only is very much limited, if only because, in the absence of their participation in the generation or manipulation of content, these companies have little incentive for discrimination against competitors in the information market". 714 F. Supp. at 5.

 The Regional Companies attempt to bolster their "experience" argument by asserting that if their bottleneck control were sufficient to produce market power, the result would have evidenced itself in the CPE (customer premises equipment) market and in the experience of the GTE Corporation. *fn39" However, as discussed at [slip op.] pp. 35-37, infra, neither the CPE experience nor that of GTE is relevant; they prove only that, where the ability or the incentive to discriminate is lacking, discrimination will not be practiced.

 Beyond that, the Regional Companies assert that practical substitutes exist for their local lines and switches (a contention with which even the Justice Department disagrees, see note 45, infra). At the same time, the companies provide no response to the intervenors' contention that their bottlenecks enable them to discriminate with respect to features necessary for the transmission of information services (see Part IV, infra).

 The Department of Justice concedes that "if an information service is accessible to customers through the public telephone network, information service providers will depend to some extent on that BOC's local exchange facilities and services." *fn40" But the Department goes on to contend that this factor does not constitute an adequate basis for the maintenance of the restriction because this Court allegedly found that a discrimination strategy would be so risky that a Regional Company would not discriminate. *fn41" That reliance is surprising for, as the Department knows, the Court made the finding referred to in the context of Regional Company entry into miscellaneous non-telecommunications businesses. *fn42" These are of course markets with wholly different contours in which, as distinguished from the information services market, the Regional Company local monopoly could play only a minor role.

 The Department of Justice and the Regional Companies next engage in a lengthy and passionate defense of vertical integration, suggesting that the restriction *fn43" herein is based on a pervasive hostility to vertical integration. *fn44" None of the Court's positions, either now or in the past, denigrated vertical integration, nor has the Department of Justice -- the author of the restriction -- demonstrated hostility to that concept.

 During the trial of the antitrust action against it, AT & T argued, just as the Regional Companies do here and now, that the antitrust effort constituted an attack on vertical integration. It was AT & T's announced expectation that, as a challenge to vertical integration, the antitrust action would be dismissed. However, the Department of Justice explained in response that a fundamental difference exists between vertical integration may be both useful economically and protected by the law, on the one hand, and a combination in one enterprise of a rate-of-return monopoly and various competitive ventures, on the other. The Court fully endorsed that position. United States v. American Tel. & Tel. Co., 524 F. Supp. 1336, 1373-74 (D.D.C. 1981). The resuscitation of the argument ten years later by AT & T's heirs does not enhance its persuasiveness.

 Finally, in answer to the intervenors' bottleneck argument, the Department recites such generalities as that independent information service providers might not even be connected to the local loops controlled by the Regional Companies -- a point in effect refuted by the Department's own concessions elsewhere *fn45" -- and that it is "aware of no evidence that the [Regional Companies] would act in concert in the provision of information services . . . ." *fn46" The Department fails to explain how there could ...


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