An Efficiency Analysis of Contracts for the Provision of Telephone Services to Prisons

I. INTRODUCTION The prison population in the United States has dramatically increased since the 1970s, and as recently as 1998, there were nearly two million inmates incarcerated in the United States. (1) As the numbers of prisons and prisoners continue to increase, so does the market for prison services. Indeed, the prison industry has already grown into a multibillion-dollar industry with its own trade shows and trade newspaper. (2) One of the more lucrative segments of this industry is the telephone market. In the prison context, the state contracts with a private entity, and the private entity provides services to the prisoners and also to the state. To the extent that the services are provided to the prisoners, the relationship resembles a third party beneficiary contract. Due to the perverse financial incentives and the political climate surrounding prisons and prisoners, however, neither the state nor the private entity acts in the best interests of the consumers in particular or of society in general. With respect to the financial incentives, it is estimated that inmate calls generate a billion dollars or more in annual revenue. (3) One prison pay phone can generate $15,000 annually; a typical public pay phone generates only one-fifth of that amount. (4) Faced with the possibility of such revenues, MCI installed its inmate phone service in prisons throughout California at no charge to the state. (5) As part of the deal, in exchange for the right to be the sole provider of telephone services to the prisons, MCI pays the California Department of Corrections a 32% share of all revenue derived from the calls. (6) MCI adds a three-dollar surcharge to each call. (7) The California example is by no means unique; it is the rule, rather than the exception. This Article will analyze the efficiency of these contracts, introduce alternate arrangements, and compare the efficiency of the present contracts to the alternatives. In so doing, this Article will demonstrate that the present contracts are inefficient. More specifically, Section II discusses problems that are unique to the provision of phone service to prisoners, and introduces the practical shortcomings of the current contracts. The Telecommunications Act of 1996, the source of Federal Communications Commission ("FCC") regulatory jurisdiction, is discussed in Section III. Section IV introduces a few basic principles used in performing an efficiency analysis. Section V uses payoff matrices and game theory to demonstrate how the award process for the contracts causes inefficiencies to arise and perpetuate indefinitely. Section VI introduces alternate contract structures and demonstrates that certain alternatives are more efficient than the present contracts. Section VII contains a brief conclusion that calls for the FCC to adopt regulation that preempts existing state contracts which are inconsistent with the most efficient alternate structure. II. NATURE OF PRESENT CONTRACTS A. Exclusive Provider Provisions The contract between the telecommunications provider and the state typically provides that the telecommunications provider will be the sole provider for a particular prison or prison system. (8) Parties to these agreements often cite the high costs of the security systems associated with the operation of a phone system in a prison as justification for the exclusive-dealing provisions. (9) Stated differently, the asserted justification is that the market is a natural monopoly, or a market that "can be served most efficiently by a single incumbent firm." (10) There are two reasons why the market is believed to be a natural monopoly: (1) the provision of telecommunications in general is best accomplished by one firm; and (2) the costs of the security system make it impracticable for more than one firm to service a prison. The first reason is based on bad economics, and as a matter of public policy, it has been abandoned by Congress. …