6. Competitive Impact Under § 854(b)(3)
Section 854(b)(3) requires the Commission to make a finding that the proposed merger does "[n]ot adversely affect competition." In assessing the impact of the proposed merger upon competition, the Commission should be informed, but not constrained, by federal antitrust laws.22 Thus, the Commission should consider the proposed merger in light of the Horizontal Merger Guidelines of the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), and apply the Hirfindahl-Hirschman Index (HHI) of market concentration. With its first-hand familiarity with the markets at issue here, however, the Commission has unique knowledge to bring an examination of the effect the proposed merger will have on the development of local competition in California.
Applicants assert that this merger should be evaluated using a "forward-looking" approach to competition analysis, taking into account the rapid expansion of wireless cellphones and other intermodal forms of telecommunications. ORA witness Selwyn and TURN witness Murray conducted a more traditional analysis of market shares. These analyses show a highly concentrated market for residential local and long distance service, and these witnesses conclude that the proposed transaction will have significant adverse effect on competition.23 Applicants criticize Intervenors' analysis, claiming that, in this case, traditional competition analysis should not apply.
We agree with the Opinion of the Attorney General (AG) on this subject. The AG Opinion states that "[t]he Guidelines require that changes in the Herfindahl index be calculated as a `starting point' in all merger reviews."24 Applicants' witness Rubinfeld apparently agrees, as he notes, "HHIs can be useful as a screen to determine what mergers might merit further investigation, and as an indicator of market power."25
Although Applicants' testimony describes competitive pressures that the two companies believe they are facing, especially with respect to intermodal competition, Applicants have not presented any empirical analyses demonstrating the extent of the competition that the merged company would actually face. Both ORA witness Selwyn and TURN witness Murray have presented empirical analyses in their testimony, applying the DOJ and FTC's 1992 Horizontal Merger Guidelines, and the April 8, 1997 revisions (Merger Guidelines).
Selwyn testified that these analyses show two things. First, many telecommunications markets are already highly concentrated, even if intermodal competition is included. Selwyn comments:
Without question, the various product/service markets in which both merger partners operate - basic local exchange service, long distance for residential and small business customers and enterprise customers - all are "highly concentrated" as the term is defined by the Guidelines. That is, all have HHIs of at least 1800 within the Verizon region prior to the merger.26
Second, according to these analyses, this transaction will increase Verizon's market power in several markets. Murray calculates that the local residential wireline market will increase by over 500 points, and Selwyn calculates that the HHI of the long distance market will increase by more than 1300 points. The Merger Guidelines consider an increase of 50 points to indicate the likelihood of increased market power, or an increased ability to exercise market power, where the post-merger HHI is greater than 1800.27
6.1. Loss of MCI as a Competitor
Applicants state that MCI will not be a significant mass market competitor in the future regardless of the outcome of the merger because MCI's mass market share is declining, as evidenced by the 37% wireline revenues decline from 2001-2004. In addition, Verizon has experienced a decline in access services consistent with the reported decrease in wireline long distance. Applicants argue that since MCI is withdrawing from the mass market, it cannot be presumed that MCI will exist in the future as a competitor.
Cox and other Intervenors contend that MCI would have remained an independent player among competitive service providers, well equipped to negotiate and arbitrate interconnection terms, drive regulatory and technology changes, and serve as a model or an ally for other competitors. They state that "MCI remains one of Verizon's largest competitors, with millions of residential access lines, many of which are in California. MCI is also a direct competitor of Verizon in the enterprise business market."28
CALTEL and Cox assert that in addition to the loss of MCI as a market competitor, there is concern about the loss of a major voice for competition in the regulatory process. Existing mechanisms to foster competition depend on tension between competitive and monopoly forces. The loss of MCI's and AT&T's abilities to negotiate reasonable interconnection agreements pits the limited resources of smaller competitors against the abilities of the incumbents to delay interconnection negotiations. Cox states that MCI's technical, operational, financial and legal expertise and resources have provided a measure of balance against the extensive resources and network advantages of Verizon, which Cox has used to its advantage by adopting portions of or the entirety of interconnection agreements negotiated by AT&T and MCI.
CALTEL and Covad further argue that the ability of the private sector to adequately regulate interconnection agreements may disappear, and costs will increase when competitors are no longer able to rely on MCI-negotiated agreements. They contend that the concept of self-regulation was central to the Telecommunications Act deregulatory approach to interconnection rights and depended on the creative tensions between companies with different objectives but equivalent resources. Relative resources of the competitors versus the incumbents will shrink from a 90% percent ratio in 1996 to a 4% ratio after the mergers.29
XO argues that the resulting imbalance will cause the existing regulatory regime to suffer. CALTEL and Covad argue that the merger disrupts the core assumption of the Telecommunications Act - namely that new entrants and incumbents should have the ability to negotiate as equals. They add: "The merger could not conceivably be in the public interest if one of its consequences would be a resource imbalance so severe that Verizon could effectively litigate its competitors out of the market."30
Whether the irreversible decline of MCI is inevitable or not, we must examine the impact of the absence of MCI on the regulatory tension between the incumbents and the competitors because MCI will not be a future presence in the regulatory arena. CALTEL, Covad and Cox have advanced objective analysis for a factor that has been anecdotally obvious to observers of the telecommunications policy debate, e.g. that MCI (and AT&T) have provided the leadership and resources to advance the competitive agenda both in this forum and nationally.
It is unknown whether a CLEC with fewer resources will have the ability to engage in an arbitration of an interconnection agreement that lasts over a protracted period of time or to fully participate in a proceeding - such as the FCC's Triennial Review - that is crucial for the future of competitive interests. That there will be an impact because of regulatory changes on the competitive landscape is certain, with the elimination of both MCI and AT&T as competitors and the elimination of UNE-P by the FCC as a vehicle for competitors to provide service. We will seek to lessen the advantage of companies with the resources to serially arbitrate provisions of interconnection agreements or to litigate or lobby their competitors out of business by adopting mitigating measures as discussed in a later section of this decision.
6.1.1.1. Mass Market/Small Business
Verizon has few wireline competitors for mass market customers. Applicants currently compete in both the local and long distance residential markets, while all parties (including Applicants) agree that virtually all competition related to UNE-P services will no longer be viable in the near future, Intervenors contend that without wireline competition from the two largest competitive entities, AT&T and MCI, the mass market will have to rely on intermodal competition to constrain Verizon's market power in its service territory and its resulting ability to increase prices. Virtually all of the intermodal competitors are based on prices significantly higher than Verizon's flat-rate residential service-for example, VoIP requires a cable modem connection (without so-called "naked DSL" discussed later) in addition to its monthly rate.31 Cell phones service plans typically range around $40 for plans with enough "included" minutes to compare with a local access line. Neither of these options, nor cable telephone, appears to be presenting a significant price pressure on Verizon.
6.1.1.2. Enterprise Customers
MCI is a direct competitor of Verizon in the enterprise market, and there is no basis for concluding that, absent the merger, Verizon would not continue to be an aggressive competitor for enterprise business. One of MCI's major strengths is its position in the enterprise market. All witnesses agree that the combined company will play a significant role in this market.
6.1.1.3. Internet Network Services
MCI is a Tier 1 Internet backbone network service provider, which means that it is able to exchange traffic with the other Tier 1 providers on a "peer-to-peer" basis without any cash payments. Verizon, on the other hand, currently provides the plurality of high-speed Internet services to California customers via its DSL offerings. According to ORA, the integration of these two networks will provide an incentive for Verizon/MCI (and SBC/AT&T) to become "mega-peers" and distort the current competitive Internet peering and intercarrier payments mechanism. A number of competitive Intervenors contend that the two "mega-peers" (Verizon and SBC) will fundamentally change the conditions under which they are willing to "peer" with smaller, non-integrated Internet backbone providers (IBPs), thereby cutting these entities out of the "peering" system and imposing out-of-pocket cash payments for interconnections with the Verizon and SBC backbones. IBPs allege that such an outcome would have a far-reaching impact upon competition for Internet services at all levels, from mass market consumer ISP services to those associated with large host sites and large enterprise customers. Verizon's response to this argument focuses upon repudiating the ability of Verizon to impose a retail-level price squeeze on cable companies and other ISPs.
The Commission's role in dealing with this dispute is limited, since primary jurisdiction for Internet regulation is with the FCC, which has considered peering allegations in its consideration of the Verizon/MCI and SBC/AT&T mergers.
6.1.1.4. Special Access
ORA's witness cited analysis filed in the FCC proceeding to show that, once MCI and AT&T no longer submit separate competitive bids, the wholesale price discount from special access rates will decrease on average by over 15%-- resulting in an overall increase in special access rates. Applicants assert that increasing special access rates is only possible where Verizon has obtained pricing flexibility-and that such flexibility, under FCC rules, is only granted where Verizon faces competitive pressure.
6.1.1.5. Intermodal Competition
Applicants argue that the presence of intermodal competition from wireless, VoIP, and cable telephony offsets the elimination of MCI as a competitor of Verizon since the presence of such services limit Verizon's market power and constrain its ability to impose monopoly prices. Intervenors, however, argue that Applicants have provided no evidence of cross-elasticity estimates between basic wireline telephony and wireless or other "intermodal" services.32 Applicants' witness Rubinfeld contends specific quantitative measures of elasticity cannot now be made, adding, "Because many of the dynamic changes in the competitive landscape have occurred so recently, it is too early to expect to see an extensive series of empirical studies relevant to market definition (e.g., accurate estimates of own- and cross-price elasticities of demand)." Intervenors argue that it is this lack of empirical studies that renders Applicants' claims of intermodal substitution too speculative to overcome the quantifiable increases in market concentration that the evidence shows will result from the merger.
We note, as do Intervenors, that Verizon is itself a major presence in each of the intermodal alternatives. Verizon holds a controlling 55% share of Verizon Wireless, the nation's second-largest wireless carrier. Following its merger with MCI, Verizon will be a major player in VoIP, adding to its local network with MCI's Tier 1 Internet Backbone Provider. Verizon also intends to become a major player in the cable television market, having announced an ambitious fiber-to-the-home (FTTH) distribution architecture over which it will provide voice, data, and video.
6.1.1.6. Additional Mitigation Measures
Given the evidence that the Verizon/MCI entity will have increased market power and an enhanced ability to increase rates because of lessened competition, ORA and TURN propose additional measures to mitigate the risk that any net ratepayer benefits from the merger may be taken away through rate increases, particularly for mass market customers. They urge that Applicants be required to:
4. Maintain a five-year rate freeze for residential and small business basic local exchange services, including 1FR, 1MR, 1MB customers. ORA adds residential inside wire maintenance plans to the list of services.
5. Make the above services available to consumers on a stand-alone basis without any requirement to purchase other bundled services.
6. List the separate availability of these services prominently (noting that there is no requirement to purchase other bundled services) in their phone books and in any advertising on Web sites or through bill inserts.
7. Retain a pricing option for California-jurisdictional long-distance calling that does not have any minimum monthly charge or fee.
Underserved consumers, including low-income, minorities, and those with disabilities are particularly concerned about the trend of companies offering telecommunications services in bundles to residential consumers, and the resulting impact on the affordability of basic phone service. Because consumers with disabilities are disproportionately represented among low-income consumers, they have a particular interest in ensuring that basic and affordable telephone service will be provided by the new entity.
We will adopt the recommendation of ORA and TURN for a five-year cap on the residential and small business basic exchange services, including inside wire maintenance plans. This condition will mitigate the risk that residential and small business ratepayers would face rate increases to pay for the short-term implementation costs of the merger. We also adopt the recommendation to make these basic services available on a stand-alone basis, to separately list the service in web sites and through bill inserts, and to retain a pricing option for long-distance calling with no minimum monthly fee. These conditions shall remain in effect during the five-year rate cap period.
6.1.1.7. Jurisdiction to Address Impacts Involving Federally Regulated Services
Since both federal agencies and this Commission are reviewing the proposed merger's public interest aspects, certain jurisdictional questions have been raised. Parties disagree concerning whether Commission review of competitive impacts under § 854 (b)(3) properly includes consideration of impacts that may involve services subject to federal regulation or review. Applicants argue that competitive impacts of such services are beyond the jurisdiction of this Commission and are more properly left for review by federal agencies.
We conclude that even to the extent that certain competitive effects of the merger may relate to services subject to federal regulation, our authority under §§ 854 (b) and (c) is sufficiently broad to encompass consideration of such effects. Section 854 (b) (3) requires, as a basis for approving this transaction, that we consider whether the proposed acquisition will adversely affect competition, as well as conditions to mitigate adverse impacts. The statue does not carve out exceptions to this requirement only for certain categories of services or competitive impacts. As we stated in D.91-05-028,
"This Commission's statutory authority to determine whether the proposed merger should be authorized, based upon the assessment of competitive impacts and their potential mitigation (§ 854(b)(2)) is meaningfully exercised only if this Commission is free to engage in the full extent of the merger's impacts on California ratepayers. The statute requires that we assess whether the merger will impact competition. If that assessment requires us to take into account certain issues regarding interstate transmission and bulk sales, then that is what we must do. Furthermore, as an administrative agency created by the Constitution, we have no power to refuse to enforce § 854(b)(2) on the basis of federal preemption, unless an appellate court has made a determination that enforcement of the statute is prohibited by federal law or federal regulation. (Cal. Const. Act. 3, § 3.5. (40 CPUC 2d, 159, 179.) (Emphasis added.)
To the extent that we impose conditions on approving this proposed merger, we do so only within the context of our obligation to assure that the merger is in the public interest pursuant to § 854. If the Applicants decide not to go forward with the merger, they would not be required to implement the mitigation measures we adopt. Thus, we are acting within the scope of the Commission's jurisdiction under § 854(b)(3).
6.1.1.8. Attorney General's Opinion
Although maintaining that § 854(b)(3) does not apply to the Verizon/MCI merger, the Assigned Commissioner in this case nevertheless requested an advisory opinion from the California AG concerning whether competition will be adversely affected by the merger, and, if so, what mitigation measures might be adopted to avoid this result. While the AG's opinion is not controlling, we accord it due weight in our deliberations.33
The Advisory Opinion was filed on September 16, 2005. In analyzing the competitive effects of the merger, the AG employed the approach embodied in the antitrust laws, including the DOJ and FTC 1992 Horizontal Merger Guidelines and the April 8, 1997 revisions. Following traditional analysis, the Guidelines analyze the effect of a consolidation upon the "relevant markets" within which the parties do business.
In summary, the AG expresses concern that the merger may adversely affect competition for two types of special access, namely, DS1 and DS3 services, but adds that there is sufficient competition to counteract any potential anticompetitive effects of the merger on these special access services. The AG concludes that the competitive effects of the proposed merger will be minimal for other relevant markets, including those for mass-market local and long distance, enterprise, and Internet backbone services.
ORA maintains that the AG has inappropriately focused upon "facilities-based" competition to the exclusion of "retail" level competition. The AG states:
Verizon has a relatively minor presence in the relevant markets for both mass market (facilities-based) long distance and enterprise services, MCI dominates neither of those highly competitive industries, and entry barriers there are relatively minor. Similarly, MCI has a nominal share of the relevant market(s) for facilities-based local exchange services, and its absence will have inconsequential effects on price and output levels."34
According to ORA, the AG appears to equate "resale" with "retail," and "facilities-based" with "wholesale," when in fact a facilities-based carrier also competes at the retail level. ORA asserts that the AG Opinion is not simply distinguishing between the facilities-based and retail segments of the two Applicants' respective businesses, it is essentially ignoring all but the "wholesale" facilities-based service production activities.
Because we conclude that the relevant market is for facilities-based services, we do not consider the question of whether MCI can still be considered an active and competitive supplier of resold services.35
The AG Opinion supports its decision to ignore "resale" by observing that UNE-P is a "readily available" service that can be used by CLECs to compete at the retail level. The AG "conclude[s] that because there are numerous suppliers of resold UNE-P telephone services, the relevant market for analyzing the effects of the merger on local exchange services is at the facilities-based level where suppliers own at least their own switches."36 However, the AG Opinion then acknowledges that UNE-P will no longer be available in the future.
Similarly, TURN contends that the AG's relevant mass market definition is contradicted by the FCC's, which includes resellers in assessing competition; and that it is contradicted by the DOJ merger guidelines that require all firms currently producing or selling in the market be included in the analysis.
Facilities-based services are not the only method of entry into the local market envisioned by Congress. The 1996 Act specifically allows for local competition through the resale of telecommunications services and the purchase of unbundled network elements.37 According to ORA, by limiting its assessment of the potential anticompetitive effects of the merger only to facilities-based competition, the AG Opinion ignores the extensive retail-level competition between Verizon and MCI that the merger will eradicate. ORA contends:
[S}ince most California ratepayers are dealing with the Joint Applicants solely at the retail level, by ignoring the retail end of the market, the AG Opinion offers the Commission no useful guidance whatsoever as to the specific public interest issues that the Commission is charged with addressing pursuant to § 854(a) in conjunction with PU Code § 451.38
It seems clear to us that in analyzing the merger pursuant to § 854, the Commission's concern must necessarily be focused primarily on California. However, the AG appears to adopt a national perspective in analyzing the competitiveness of the U.S. telecom industry. For instance, in assessing the mass market long distance services, the AG Opinion relies upon the following FCC findings:
...that competition among long distance suppliers is both substantial and national in scope. AT&T, MCI, and Sprint served the vast majority of the market when the FCC found for the first time in 1995 that it was "structurally competitive.39"
...that the United States is the relevant geographic market for assessing competition among long distance suppliers.40
The first of these FCC findings was made in 1995, before the federal Telecommunications Act of 1996 was enacted, and at a time when none of the regional Bells was permitted entry into long distance. The second FCC finding was made in 1998 in the context of the then-proposed merger of WorldCom and MCI, two interexchange carriers, neither of which had any significant presence in the mass market local service segment. In addition, it was more than two years before any of the RBOCs had been granted authority pursuant to § 271 of the 1996 Act to offer interLATA long distance services.41
Congress has since recognized that the "relevant geographic market" for long distance service, post-RBOC entry, is not national in scope. Section 271(b)(2) of the 1996 Act authorizes RBOC long distance entry out-of-region immediately as of the date of enactment.42 But § 271(b)(1) provides that "A Bell operating company, or any affiliate of that Bell operating company, may provide interLATA services originating in any of its in-region States (as defined in subsection (i)) if the Commission approves the application of such company for such State under subsection (d)(3)" thus clearly contemplating a state-by-state compliance analysis.43
The AG Opinion focuses on the national markets and on facilities-based services. It also does not address the fact that Verizon will increase its market shares. Verizon controls much of the critical last mile infrastructure in its service territory. Because of Verizon's already-dominant position, the elimination of one of its largest competitors should not be minimalized simply because MCI uses UNE-P for its local exchange services.
Accordingly, we will not rely primarily on the AG Opinion, but will also give substantial weight to parties' expert testimony proposing further conditions.
22 Re Pacific Telesis Group (1997) D.97-07-037.
23 Ex. TURN 1 (Murray/Kientzle) at 228; Ex ORA 1 (Selwyn) at Table 2.
24 AG Opinion at 10 (citing Merger Guidelines at § 2.0).
25 Ex. Verizon/MCI 22 (Rubinfeld) at para. 73.
26 Ex. ORA 1 (Selwyn) at 88.
27 Merger Guidelines at 1.51(c).
28 ORA, Selwyn, p. x.
29 CALTEL & Covad, Gillan, p. 10 - 14.
30 CALTEL & Covad, Gillan, p. 6, l.12
31 Ex. ORA 1 (Selwyn) at Table 4.
32 Ex. ORA 1 (Selwyn) at 96.
33 D.97-03-067, 71 CPUC2d 351, 420, footnote 31. Also see Attorney General's Opinion, page 3, citing Moore v. Panish (1982) 32 Cal.3d 535, 544, and Farron v. City and County of San Francisco, (1989) 216 Cal.App.3d 1071.
34 AG Opinion at 11.
35 AG Opinion at 12.
36 AG Opinion at 9.
37 See 47 U.S.C. § 251(c)(3) and (4).
38 Section 451 requires that all rates "by any public utility," including telephone companies, "shall be just and reasonable."
39 AG Opinion at 13 (footnote omitted).
40 AG Opinion at 14.
41 47 U.S.C. § 271.
42 47 U.S.C. § 271(b)(2).
43 47 U.S.C. § 271(b)(1).
