How The Obama Administration Is Rewriting Competition Law At The FCC

In his first presidential campaign, then-Senator Obama said “antitrust is the American way to make capitalism work for consumers,” because, “unlike some forms of government regulation, it ensures that firms can reap the rewards of doing a better job” and “insists that customers … are the judges of what best serves their needs.” Obama vowed to “reinvigorate antitrust enforcement” and work with other jurisdictions to “curb the growth of international cartels” so that “all Americans benefit from a growing and healthy competitive free-market economy.”

Regrettably, the Obama presidency’s competition policies have not matched his campaign rhetoric. According to Daniel Crane, a law professor at the University of Michigan, Obama has not reinvigorated antitrust enforcement: “With only a few exceptions, current enforcement looks much like enforcement under the Bush Administration.”

Obama has instead shown a strong preference for relying on other forms of government competition regulation — the kind that prevents firms from reaping the rewards of their investments in American infrastructure and limits what customers can demand — while complaining about the antitrust enforcement efforts of other jurisdictions that might affect U.S corporate interests. In the process, the Obama Administration has slowly been rewriting U.S. competition law in unprecedented ways.

This process has been especially apparent in communications regulation at the Federal Communications Commission (FCC). Though it was once seen as a “sleepy backwater,” the FCC has radically transformed its approach to competition law during the Obama Administration. The FCC’s new approach to competitive analyses runs the risks of spillover to interpretation of antitrust laws and speculation regarding the limits of government intervention in business transactions throughout the economy.

The Pre-Obama FCC’s Market Power Approach

The Obama FCC’s aggressive role in spearheading competition policy is unusual. When the FCC was created in 1934, it was directed to regulate a state-sanctioned telephone monopoly, not to protect competition (a task primarily delegated to the Department of Justice and Federal Trade Commission). In the early 20th century, state laws typically prohibited competition among telephone companies, because the market was considered a “natural monopoly” (i.e., policymakers presumed the market could support only one telephone company, which would inevitably have market power). Rather than preempt state laws restricting competition, Congress chose to constrain the telephone monopoly through “Title II” of the Communications Act, which requires “telecommunications” carriers to provide service at “reasonable rates” (under section 201) and without “unreasonable discrimination” (under section 202) as determined by the filing of tariffs at the FCC under section 203 (“Congress’s chosen means of preventing unreasonableness and discrimination in charges”).

When the FCC began permitting competitive entry in long distance telephony (circa the 1970s), it initially applied this monopoly-era regulatory scheme to new entrants without considered analysis. (Tariffs Evidence, 40 F.C.C. 2d 149, 154–55 (1973).) After nearly a decade of experience observing the results, however, the FCC found that imposing economic regulation on competitive carriers reduces incentives for investment and innovation without producing the expected public benefits of Title II “precisely because no public benefits from the application of these traditional rules to [competitive] carriers is possible.” (First Competitive Carrier Order, 85 F.C.C.2d 1 at para. 4 (1980).) Based on a fundamental principle of U.S. antitrust law — that a firm without market power “cannot systematically harm consumers” — the FCC concluded that firms lacking market power are simply “incapable of violating the just and reasonable standard of 201(b)” or “the type of unlawful discrimination condemned by Section 202(a) of the Act.” (Id. at paras. 88-89.) The FCC thus embraced market forces as the primary means of ensuring that the rates, terms, and conditions of communications services are just and reasonable and exempted “non-dominant” carriers (i.e., carriers that lack market power) from ex ante economic regulation under Title II.

Congress codified this approach in the Telecommunications Act of 1996, which was designed to “promote competition and reduce regulation in order to secure lower prices and higher quality services for American telecommunications consumers and encourage the rapid deployment of new telecommunications technologies.” Though it presumed that incumbent local telephone companies could still exercise market power when the 1996 Act was adopted, Congress envisioned an era in which market-based competition would completely supplant Title II regulation as the primary means of meeting the goals of sections 201 and 202 of the Communications Act. Congress thus gave the FCC “express authority to eliminate unnecessary regulation and to carry out the pro-competitive, deregulatory objectives that [the agency had] pursued” since 1980.

Title VI” of the Communications Act applies a similar competition-based approach to cable and satellite video services. The economic regulations in Title VI generally apply only to cable operators who had market power when the Cable Act was adopted in 1992, and several provisions no longer apply now that the video marketplace is effectively competitive.

The Obama FCC’s Gatekeeper Theory

During the Obama Administration, the FCC has rejected the foundational principle of U.S. competition law (that firms without market power cannot systematically harm consumers). In its first net neutrality order, the Obama FCC adopted a new “gatekeeper” theory to justify comprehensive economic regulation of internet communications systems without regard to the availability of competitive options for consumers.

The FCC’s gatekeeper theory posits that even an internet service provider (ISP) without market power has the incentive and ability to “force edge providers to pay inefficiently high fees because that [ISP] is typically an edge provider’s only option for reaching a particular end user.” In contrast to the competition-based theories that underlie communications regulation in Congress’s 1934 and 1996 legislative acts, Obama’s gatekeeper theory of ‘monopoly’ pricing “do[es] not depend upon broadband providers having market power with respect to end users” because, according to the FCC, the “costs of switching from one ISP to another are too high for competition to prevent ISPs from setting ‘inefficiently high fees’ for edge providers.” The gatekeeper theory thus conclusively presumes that ISPs that lack market power can nevertheless charge ‘monopoly’ rates to edge providers unless “the market for [edge provider] offerings include[s] all U.S. end users” at all times. In antitrust terms, net neutrality categorizes vertical relationships (e.g., exclusive contracts) between ISPs and edge providers as harmful per se.

This per se ban on vertical relationships is inconsistent with longstanding FCC precedent, congressional findings embodied in communications legislation, antitrust law, and relevant court decisions.

The FCC’s imposition of a total ban on economic arrangements between any ISP (irrespective of market power) and any edge provider (irrespective of affiliation) is impossible to reconcile with the law governing video distribution. In the cable and satellite video context, the statutory scheme doesn’t impose a per se ban on exclusive programming contracts even with respect to cable operators who actually have market power. The 1992 Cable Act did establish a presumption that exclusive distribution arrangements between cable operators (who clearly had market power) and their affiliated programming vendors were harmful. But Congress permitted cable operators to rebut even that presumption because exclusive contracts can “serve the public interest by providing offsetting benefits to the video programming market or assisting in the development of competition among” video distributors.

Congress also recognized that effective competition from satellite and other video distributors would eliminate the need for this rebuttable presumption and provided that it would expire automatically on its tenth anniversary unless the FCC found it “continue[d] to be necessary to preserve and protect competition and diversity in the distribution of video programming.” In 2012, the FCC found the presumption is now unnecessary because cable operators are no longer “dominant” (i.e., generally lack market power) nationally.

The net neutrality orders’ reliance on switching costs to justify pervasive economic regulation is also inconsistent with federal court precedent in the video context. In an order reversing FCC limits on cable ownership, the D.C. Circuit Court of Appeals concluded that “the assessment of a real risk of anti-competitive behavior … is itself dependent on an understanding of market power,” which is “determined by the availability of competition.” The court noted that, according to the law of supply and demand, “If [a cable operator] refuses to offer new programming, customers with access to an alternative may switch,” and found there was no reason to assume this “logic does not apply to the cable industry.”

In its net neutrality orders, however, the FCC claimed that the potential costs of switching ISPs are sufficient to negate the law of demand. On review of the FCC’s first net neutrality order, the D.C. Circuit Court noted that, “if end users could immediately respond to any given broadband provider’s attempt to impose restrictions on edge providers by switching broadband providers, this gatekeeper power might well disappear.” But, this time, the court saw no basis for questioning the FCC’s conclusion that end users are unlikely to switch ISPs if they impose restrictions on edge providers. The court held that ISPs’ “ability to impose restrictions on edge providers” does not depend on market power, it “simply depends on end users not being fully responsive to the imposition of such restrictions.” If the court’s holding is following to its logical conclusion, a federal agency can now justify pervasive economic regulation irrespective of market power whenever consumers are not “fully responsive” to market conditions.

The threshold for finding that consumers are not fully responsive to market conditions is extraordinarily low. According to the FCC, a consumer “may incur significant costs in switching” ISPs due to “informational uncertainties,” equipment incompatibility, bundled services, and fees associated with early termination, activation, or installation of service. But the FCC made no effort to (1) quantify these costs, (2) determine the extent to which these costs actually inhibit consumer switching, (3) determine the extent to which these costs are applicable across all ISPs, or (4) draw a connection between the extent to which consumers actually are responsive to market changes and the ability and incentive of ISPs to restrict edge providers.

For example, with respect to the second issue, there is no evidence that the unquantified costs identified by the FCC significantly inhibit consumer switching among ISPs. According to a survey conducted by the FCC in 2010, 63% of broadband consumers with a choice of multiple providers “said it would be easy to switch providers,” with 33% saying it would be very easy, 30% saying it would be somewhat easy, 21% saying it would be somewhat difficult, and only 10% saying it would be very difficult or impossible.

Average churn rates (e.g., the rate at which customers drop their service provider) among ISPs also indicate that switching costs are not significant. The FCC’s 2010 survey indicates the annual churn rate for ISPs serving homes is over 17 percent, and the agencies most recent mobile competition report indicates that average annual churn rates for mobile ISPs ranged from 17 to 22 percent from 2012 to 2015. The FCC has described an average churn rate of 22% as “a significant challenge for the [mobile] industry” because “lowering churn [e.g., by lowering customer incentives to switch] increases profitability.”

The FCC tried to avoid this data in its first net neutrality order by claiming that churn was “not probative as to the extent of competition among broadband providers because it does not appropriately isolate a connection between churn levels and the extent of competition.” This statement, however, contradicts an FCC finding from the same year that churn rates “can serve as a reasonable proxy to measure whether or not consumer switching costs are detrimental to competition” and the National Broadband Plan’s recommendation that the FCC collect “data on customer churn” to evaluate switching barriers.

The Obama FCC’s sudden refusal to consider churn data as probative with respect to competition is also inconsistent with the agency’s previous competitive analyses. For example, in its President Clinton-era order deregulating AT&T’s long distance services, the FCC relied on a “high churn rate” of 20 percent to determine that long distance customers were “highly demand elastic and will switch to or from AT&T in order to obtain price reductions and desired features.” (AT&T Non-Dominance Order, 11 FCC Rcd. 3271 at para. 63 (1995).)

Potential Impact On Antitrust Law

The logic of the FCC’s gatekeeper theory isn’t limited to internet service providers. As Judge Silberman noted in his separate opinion in the D.C. Circuit’s first net neutrality opinion, any intermediary between a consumer and an upstream seller is a “gatekeeper.”

All retail stores, for instance, are ‘gatekeepers.’ The term is thus meaningful only insofar as the gatekeeper by means of a powerful economic position vis-a-vis consumers gains leverage over suppliers.”

The FCC’s gatekeeper theory and the court decisions upholding it thus indicate that the existence of switching costs is alone enough to give a gatekeeper sufficient anticompetitive leverage over a supplier to warrant pervasive economic regulation of any industry with fewer than four nationwide competitors.

Given that there are many industries with switching costs similar to ISPs, this result could have significant consequences for antitrust law, especially with respect to the “essential facilities doctrine.” In the U.S., a private firm is ordinarily free to exercise its own independent discretion as to the parties with whom it will deal and has no duty to share its facilities or resources with others. Compelling firms to share a source of their competitive advantage “is in some tension with the underlying purpose of antitrust law, since it may lessen the incentive for” investment in economically beneficial facilities. Antitrust law thus recognizes a duty to deal only when a facility is controlled by a monopoly firm and competing firms lack a reasonable ability to reproduce the facility, because “new entrants must either be allowed to share the bottleneck facility or fail.” (First Competitive Carrier Order, 85 F.C.C.2d 1 at para. 59.)

The gatekeeper theory effectively adopts the “bottleneck” analysis of the essential facilities doctrine — that without compelled access to ISP facilities, edge providers would fail — but substitutes switching costs for the monopoly and facility reproduction requirements. The FCC’s net neutrality orders concluded that, if ISPs had charged for priority access, “some innovative edge providers that have today become major Internet businesses might not have been able to survive.” Indeed, all of the potential “harms” to edge providers that were identified in the FCC’s net neutrality orders (discrimination in favor of ISP services and “excessive” charges) are based on traditional anticompetitive harms that justify government intervention under antitrust law. The D.C. Circuit Court’s opinion holding that the FCC’s gatekeeper theory is reasonable thus implies that the same theory would reasonably support a claim for relief under antitrust law in other industries as well.