Opinion ID: 539780
Heading Depth: 2
Heading Rank: 2

Heading: Manufacturing

Text: 39 The manufacturing restriction, imposed by section II(D)(2) of the decree and amended by section VIII(A) is really more properly conceived of as two restrictions. First, it forbids the BOCs from manufacturing (but permits them to provide) customer premises equipment (CPE), which includes equipment employed on the premises of anyone other than a carrier that is utilized to originate, route, or terminate telecommunications. 673 F.Supp. at 552 n. 116. Second, it prohibits the BOCs from manufacturing or providing telecommunications equipment, that is, equipment other than CPE used by a carrier to provide telecommunications services. See id. The BOCs petitioned, with DOJ support, for the complete removal of the manufacturing restriction, and the district court left the restriction intact.
40 The BOCs and the DOJ argue that market changes since the decree and regulatory adaptations to the post-divestiture market warrant removal of the telecommunications equipment restriction. The Justice Department further divides the telecommunications equipment market into separate markets for central office switches and for transmission equipment (primarily metal cable). The DOJ makes the significant concession that any BOC that chooses to manufacture central office switches, either unilaterally or through a joint venture, will buy all (or nearly all) of its requirements from the affiliated producer--thereby foreclosing a certain portion of the market, whether or not there are economies to be gained from such integration. 19 Nevertheless, the BOCs will not impede competition (although competitors will surely be hurt) in the switch market, it is argued, because large economies of scale would prevent any BOC from remaining in the market solely to sell to itself. Even the largest BOC buyer of switches in 1985 purchased only 1.4 million lines of new switching capacity, about 17 percent of the U.S. market. Only two other BOCs purchased over one million switches and two BOCs bought less than 500,000. Huber Report at 14.8. The Huber Report estimates that switch producers must sell upwards of 1.5 million switches per year to survive and many more to be profitable. Huber Report at 14.15-14.16. Of the three major U.S. switch producers, two (AT & T and Northern Telecom) sold over 4.5 million switches in the U.S. in 1985, and perhaps twice that many worldwide. The third (GTE) sold only about 1.5 million switches in 1985 and is losing money in its equipment businesses. Huber Report, 14.8, 14.14-14.15. Assuming that there are no joint ventures among BOCs (which the DOJ admits would alter its assessment), the DOJ argues that only a few BOCs would enter the switch market and those that did could not afford to produce idiosyncratic (or overpriced) switches since they would have to attract at least some significant number of nonaffiliated buyers who, of course, can choose among many producers. 41 The DOJ further concedes, however, that the image they convey of the efficient BOC producer of switches is somewhat clouded by the danger of anticompetitive interconnection discrimination and of cross-subsidization. The risk of interconnection discrimination, by which a BOC would design its switches in a way that would favor the BOC's self-produced equipment over rival manufacturers, has allegedly been substantially decreased by more effective regulatory control--especially the availability of benchmark comparisons among the BOCs. 20 Cross-subsidization is a plausible concern in the switch market, the DOJ tells us, because of the need to attract a large market share, the extensive shared costs with local exchange services (especially research and development) (R & D), and traditional difficulty encountered by regulators in discovering cost misallocations. Indeed, according to the DOJ, a BOC might not have to produce efficiently to attract its own operating companies as buyers if regulators did not prevent recovery of excessive switch costs. And while the risk of cross-subsidization cannot be eliminated completely, FCC regulation--especially the availability of benchmarks to enforce effective accounting rules--would significantly mitigate it. 21 Finally, the DOJ maintains that a small amount of cross-subsidization would not impede competition in the entered market; rather its primary effect would be to raise the price of local exchange service, a problem that the DOJ suggests is to be handled by regulators and is irrelevant to this proceeding. 42 The DOJ's assessment of the transmission equipment market is substantially similar to that for central office switches. In the transmission equipment market, as was true of central office switches, any BOC would purchase all or most of its own equipment from its own manufacturing affiliate; not all BOCs would manufacture every type of transmission equipment. There is some danger of discrimination and of cross-subsidization, but, due in large part to the availability of benchmark comparisons, that risk is substantially less than it was prior to divestiture. Among the salient differences is that the market has supported competition even though the BOCs have already been allowed to provide transmission equipment in the form of CPE, and therefore already possesses an incentive to discriminate in interconnection. In addition, cross-subsidization is allegedly less probable than in the switch market because R & D costs, normally the prime source of cross-subsidization, are so low. 22 43 Even if we did accept the DOJ's market forecasts and regulatory assessments wholesale, it would not suffice to compel removal of the telecommunications equipment restriction under the section VIII(C) standard. As we discussed above in Part II(C), the possibility of self-dealing bias in the telecommunications equipment market poses dangers to competition that do not exist in the other markets the BOCs seek to enter. The DOJ's submissions provide little solace against those dangers. As we noted above, the DOJ assumes that any BOC that manufactures equipment would purchase substantially all of its requirement from its affiliate, presumably regardless of price or quality. While the BOCs and the DOJ contend that not all BOCs will produce each type of equipment and therefore dispute the district judge's conclusion that the BOCs would foreclose 70% of the telecommunications equipment market, there seems to be no dispute that some substantial portion (5-15%) of the equipment market will be foreclosed. 44 Such foreclosure, if combined with cross-subsidization, would appear to allow the BOCs, in effect, to raise prices (and therefore exercise a form of market power) in the foreclosed sectors of the equipment market by disguising inflated equipment prices as costs in the local exchange market. See supra Part II.C. To be sure, the DOJ advised the district court that FCC regulation would substantially reduce the risk of cross-subsidization. In its own reports on the two principal telecommunications equipment submarkets, the DOJ nevertheless concedes that the BOCs would possess both the incentive and the ability to cross-subsidize, at least somewhat. The DOJ and the BOCs nowhere explain, however, why any significant amount of cross-subsidization that, in practical terms, enables the BOCs to charge higher prices for the equipment it produces would not be akin to an exercise of market power that would impede competition in the telecommunications equipment market. At least in this first Triennial Review, it is not enough for the BOCs (independently or through the DOJ) to show that a significant number of stable competitors will be able to survive BOC entry. We think that the BOCs cannot meet their burden under section VIII(C) without also explaining why foreclosure combined with cross-subsidization does not itself pose a substantial possibility that the BOC could use its monopoly power in the telecommunications equipment market.
45 The DOJ subdivides the CPE market into the private branch exchange (PBX) market and the terminal equipment market. While it analyzed those submarkets separately, the DOJ believes--for reasons similar to those offered for the telecommunications equipment market--that BOC entry into both would not threaten competition. The PBX market is described as moderately concentrated--with three major and many minor producers--but nevertheless competitive. The DOJ points out that the BOCs have been permitted to provide PBXs (as well as all other forms of CPE) since the decree, and that they therefore have always had the incentive to provide discriminatory interconnection. If allowed to produce PBXs, that discrimination could manifest itself through BOC manipulation of its local network or through discriminatory dissemination of network information. We are assured, however, that the BOCs' ability to discriminate will be blocked, as it has been until now, by numerous obstacles, especially FCC regulation. 23 Similarly, any danger of cross-subsidization in the PBX market is dismissed by the DOJ as negligible. 46 The DOJ's argument with respect to the terminal equipment market is based again on the premise that no BOC could successfully discriminate against its rivals, either by way of interconnection or by failing to provide critical network information. Their ability to discriminate is asserted to be undercut somewhat by the advent of PBX use, as well as cellular and paging systems for which the BOCs do not even provide the interconnection with the terminal equipment and which all contribute to the prevalent use of standards in interconnection. Residual risk of discrimination, as well as the risk of cross-subsidization, are adequately prevented by FCC regulation. 47 While we certainly have some reservations concerning the DOJ's assessment of the CPE market, 24 we are inclined to think that the question is much closer than it was for telecommunications equipment. Since the BOCs purchase only a minute percentage of the nation's CPE output, there is no risk of the combined cross-subsidization and foreclosure that is so crucial to our decision on telecommunications equipment. Indeed, on appeal, the BOCs and the DOJ complain primarily that when the district judge discussed foreclosure, he did not differentiate between CPE and the various types of telecommunications equipment that the BOCs do purchase themselves in great quantity. While we agree that different competitive concerns should motivate decisions regarding CPE than those regarding telecommunications equipment, we do not perceive that as a reason to upset the district court's decision as it applies to CPE manufacturing. The burden under section VIII(C) is not on the district judge; it is on the petitioning BOCs to show that they can enter certain markets without raising a substantial possibility that they could use their monopoly power to impede competition in those markets. In this Triennial Review, the BOCs petitioned for complete removal of the manufacturing restriction, and the DOJ explicitly urged the district judge not to distinguish between the two types of equipment in making his decision, because line-drawing between them is so difficult. Given the risks to competition we identified in the telecommunications equipment market, the district court understandably did not allow the entire manufacturing restriction to be removed in this first Triennial Review, and the motions were properly denied.