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Weekly UpdatesI. THE ISSUE
For several decades, U.S. policy in telecommunications and electronic mass media focused on the encouragement of competition. This policy, usually known as deregulation but more accurately described as liberalization, is aimed at an opening of the market to competitors and a reduction of market power. There were numerous elements and proceedings to this policy by the Federal Communications Commission ("FCC"), the states' public service commissions and legislatures, the courts, and Congress. Of these actions, none was more comprehensive than the Telecommunications Act of 1996 ("1996 Act").
What has been the impact of this policy? In this Essay, I will focus on one dimension: the impact of liberalization on market concentration.
This question has acquired some urgency in light of the meltdown in the telecommunications sector following the boom years of the 1990s. That downturn may be temporary, and the industry will recover. But the more fundamental issue is that the telecommunications industry may have entered into a pattern of boom-bust cycles.
While business cycles are traditional to many industries, in telecommunications they are a new phenomenon. Telecommunications used to be less volatile than the economy as a whole. It grew steadily, with long planning horizons hardly ruffled by the business cycle. But today, in sharp contrast, the telecommunications sector is potentially more volatile than the economy, more like the airline business and less like water utilities.
Perhaps the major reason for instability has been the fundamental economic characteristic of many network industries with high fixed costs and low marginal costs. The telecommunications industry is characterized, on the supply side, by huge investments followed by tiny costs of serving additional customers, plus positive network externalities on the demand side. This creates economies of scale, scope, and networking. The resultant incentives are to be large and to expand early, which in the aggregate creates industry-wide overcapacity. Price competition then drives down prices to unprofitable levels. In telecommunications, price differentiation and asset redeployment are difficult, much harder than for airlines. Bust cycles follow. We have encountered the first of these cycles, but surely not the last, because the factors of instability will remain: low marginal costs, high fixed costs, inelastic demand, positive network externalities, lags in supply, disinvestment and regulation, and a Wall Street short-term perspective that amplifies industry cycles.
If instability will be part of the environment, what will telecommunications companies do? The textbook responses are to cut costs, lower prices, differentiate products, and increase innovation. But these strategies can be expensive and will quickly be matched by competitors, which will leave every supplier firm even worse off.
The other major strategy will therefore be to raise prices above competitive levels, and to reduce competition and the commodification that lowers profitability and future investments. To do so requires market power by a single firm or an oligopoly.
II. THE CHANGING INDUSTRY STRUCTURE
We have, so far, concluded that industry concentration is a likely response to competition. Let us now turn to the empirical evidence for such concentration in telecommunications and related information industries. To provide an empirical answer, we looked at the market concentration trends in the American information sector for 100 separate industries. (1) Examples for such industries are long-distance telecommunications, cellular mobile communications, broadcast TV, cable TV, film distribution, daily newspapers, and Internet service providers. For each of these industries, we tracked and calculated individual firms' market shares and revenues in this particular industry, using a variety of sources, for a period of twenty years.
These market shares were then used to calculate concentration indices and to follow them over time. The major concentration index used was the Herfindahl-Hirschman Index ("HHI") of the U.S. Department of Justice. (2)
HHI = [f.summation over (i=1)] [S.sup.2.sub.i]
Where f = number of firms participating in an industry; Si = each firm's market share; i = firm in a given industry
The U.S. government's antitrust enforcement guidelines classify market concentrations according to their HHI score:
HHI < 1,000: Unconcentrated Market
1,000 < HHI: Moderately Concentrated Market
1,800 < HHI: Highly Concentrated Market
The HHI is the sum of the squares of the market shares. For example, if a market is shared by three firms with 30% each, and five firms of 2% each, the HHI is 3 x 900 + 5 x 4 = 2720.
We then tracked these indices of concentration over time, from the years 1983 and 1984, just before and just after the AT&T divestiture. The year 1996 was the important midpoint, permitting a comparison of the trends preceding and following the 1996 Act.
We then proceed to aggregate the individual industries along the dimensions of broader sectoral categories such as telecommunications or mass media, and along the dimensions of regulated industries, such as whether they are regulated telecommunications industries or not. The weighted aggregate HHI is defined as:
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]
Where j = an industry; [m.sub.j] = total revenue of an industry; [S.sub.i] = each firm's market share of an industry; n = number of industries in a specific subset of the information sector; f = number of firms in an industry. (3)
We look at the four major subsectors of the information sector: (1) Telecommunications, (2) Mass Media, (3) Internet, (4) Information Technology ("IT"). For each of those sectors, we define two categories of industries: (a) Regulated (e.g., local telecommunications, TV stations); (b) Unregulated (e.g., film distribution, fax machines).
HI. EMPIRICAL FINDINGS
For the telecommunications industries, the findings can be seen in Graph 1. (4)
[GRAPHIC 1 OMITTED]
Points below the lower horizontal line are below HHI of 1000, i.e., in the range of unconcentrated industries. HHI points above the upper horizontal line are in the concentrated range of > 1,800. Unregulated telecommunications industries decline in concentration in the 1980s, after the AT&T divestiture, which opened equipment and long-distance markets. The trend is flat after 1988, and industry concentration is high. After 2001, with the large equipment makers in decline, market concentration dropped still further.
But most interesting is the concentration trend of the regulated telecommunications industries: starting at highly concentrated levels in the early 1980s, overall concentration declines, especially after the 1983-84 AT&T divestiture, but also thereafter until 1996--the year of the deregulatory 1996 Act. Around that time, the concentration level is at its lowest, though barely touching the bottom range of high concentration. But following that period, concentration rises again.
We also conducted similar calculations for the mass media industries. (5) Several of these were also affected by the 1996 Act. Graph 2 reports concentration trends for regulated mass media and telecommunications industries.
[GRAPHIC 2 OMITTED]
The concentration of regulated mass media industries first declines in the 1980s, is flat in the early 1990s, and rises around 1996 and continues to do so until 2004-05. Its levels are much lower than those for telecommunications industries. Regulated mass media industries concentration increased steadily, from low levels in the 1980s and early 1990s--maintaining low levels perhaps by regulation--and rose rapidly after 1996, which experienced an intermediate level of concentration. Concentration levels for both regulated telecommunications and regulated mass media have increased steadily after 1996.
To contrast these findings, we next look at the unregulated mass media and telecommunications sectors and also at the Internet and IT subsectors, both of which are unregulated. The findings in Graph 3 show that unregulated industries' concentration was mostly flat after 1996. The exceptions were the Internet industries that consolidated and moved to a model, in each subindustry, to dominance by a few players. (6) We conduct the same analysis for the Internet sector in Graph 3. (7)
[GRAPHIC 3 OMITTED]
Next, we group all unregulated information industries together and contrast them with all regulated information industries.
What the results show is that the concentration level in the unregulated information industries is moderate and almost flat. For the regulated and affected industries, on the other hand, concentration is high and declining in the 1980s and early 1990s, and rising after 1996. It is still lower than it was after the AT&T divestiture.
[GRAPHIC 4 OMITTED]
A. Vertical Concentration
Next, we look at vertical concentration trends. If the same small set of companies expanded their activity from one industry to several others, vertical concentration would rise. Regulation might restrict such expansion, and deregulation would permit it. What has been the trend over the past twenty years, especially after 1996? Graph 5 shows the shares of the top five companies in each of three sectors. Consistently, the top five telecommunications firms have a higher sector share than that of IT and mass media. (8) This share of the top five in telecommunications was virtually 100% in 1983. After the divestiture this share came down to about 75%. It dropped further with new entrants and technologies such as wireless and rose again after the mid-1990s. In the mass media sector, the share of the top five firms rose gradually and steadily, slowing down after 2001. It more than doubled since 1988, but is lower than for telecommunications or IT. For IT the trend is U-shaped, rising after the mid-1990s.
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