Freeman

ARTICLE

Merger Policy Fails Hi-Tech Test

Competition Is Not a Static, Zero-Sum Battle

JUNE 01, 2000 by HENRY DEMMERT

Henry Demmert is associate dean of the Leavey School of Business at Santa Clara University.

A true story: In the early 1980s I worked as an economist in the Antitrust Division of the Department of Justice. In my first assignment I was paired with one of the division’s experienced lawyers to evaluate a merger between two electronics firms. My first step was to visit the lawyer, introduce myself, and begin preliminary discussion of the task before us. We got right down to business. Or at least he did, insisting that this was clearly an anticompetitive merger and our job was to block it. I asked how he had reached this conclusion so quickly. By what measure, which I surely had missed, was it so clear that the merger would lessen competition? His response: “There are 22 competitors in the market now. If we allow this merger, there will only be 21 left. That’s less competition.”

I’ll be the first to admit that this particular lawyer’s terribly naive view of competition is not representative of everyone at the Antitrust Division, and certainly not of the economists. But it is instructive as an extreme version of the view of competition that the Division uses in formulating antitrust policy, especially merger policy. It is a view that is enshrined in the Division’s merger guidelines.

The guidelines were first introduced in 1968 in an attempt to eliminate what, at the time, was a great deal of uncertainty over the kind of merger the antitrust authorities would challenge. Although these guidelines have often been revised, the last time in 1994, the essential approach remains unchanged. The focus is on “market structure.” That is, the antitrust authorities define a market, geographically and by product, in which the merging firms compete. They then measure the market shares of each of the merger partners as well as the overall level of “concentration” in the market—the extent to which a few large suppliers account for a substantial share of total market sales. If the combined shares of the merger partners is too high or the market is too concentrated, the merger will likely be challenged by the feds. Their fear is that too large a firm will wield enough “market power” to raise prices or that a market with a few significant suppliers is susceptible to collusion.

This view is essentially static and backward-looking. It is questionable, at best, when applied to steel and autos, but it is downright misleading when applied to the rapidly changing world of high technology. The recently proposed merger between MCI WorldCom and Sprint illustrates the wrong-headedness of the current approach.

MCI WorldCom and Sprint are the second and third largest suppliers of U.S. long-distance telephone service. The combined firm would have a market share of 35 percent. With AT&T’s 45 percent share, the merger would leave a highly concentrated market in which the two largest suppliers account for 80 percent of all long-distance service. By the standard measures, the merger violates the guidelines. Indeed, shortly after it was announced, one federal regulator expressed concern about greater concentration in long-distance services and warned that “any further consolidation among the major [long- distance] providers would be intolerable.”[1] But defining the relevant market as “long-distance services” is arbitrary and misleading.

Dynamic Environment

Deregulation and technology are interacting to create an environment in which the only certain thing we can say about the telecommunications market of the future is that it will look nothing like it does today. The Telecommunications Act of 1996 eliminated the archaic regulatory barriers that once separated local phone service, long-distance phone service, and cable, while new technologies are erasing the lines between almost all forms of communication and information-sharing.

Moreover, with the global reach of the Internet, and with foreign giants such as Germany’s Deutsche Telekom and Japan’s NTT now free to enter the U.S. market, what is emerging is a global telecommunications market in which the major players, to be competitive, will have to offer “all-distance” wireless broadband service not just for voice, but for data and video as well.

Firms are scrambling to remain competitive. The spate of recent mergers in telecommunications reflects the emerging new realities. Bell Atlantic merged with Nynex and GTE, which had acquired BBN, a long-distance and Internet provider. U.S. West, one of the Baby Bells, merged with Qwest, another Internet and long-distance provider. SBC Communications acquired two former Baby Bells, Pacific Bell and Ameritech. AT&T acquired TCI Cablevision and is in the process of merging with Media One. And, of course, there is AOL’s proposed blockbuster acquisition of Time Warner Communications.

The trend is global as illustrated by the proposed acquisition by British Vodaphone of Germany’s Mannesmann, which analysts believe will “unleash a flurry of deals among other wireless companies seeking to compete on a global scale.”[2]

As separate entities, MCI WorldCom and Sprint would likely founder in this brave new world; combined they will create a more effective competitor. To think that they would have enough market power to raise prices, or that collusion is a danger in such a rapidly changing environment, requires a real stretch of the imagination.

Properly understood, competition is not a static, zero-sum battle for shares in an arbitrarily defined market. Rather it is a process of discovery and innovation, a process that continually expands existing markets and opens up new ones. In the world of high technology, where this process is especially rapid, the old models no longer apply. To formulate merger policy as if they did would be to stifle the creative energy that true competition channels into social benefits.


Notes

  1. “FCC Staff Member Objects To Sprint-MCI Buyout Plan,” Wall Street Journal, December 13, 1999.
  2. “Vodaphone Deal May Spur Globe Roaming,” Wall Street Journal, February 4, 2000.

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June 2000

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