August 20, 1995
"Telecommunications Deregulation and the Cellophane Fallacy"
San Jose Mercury News
By Timothy Taylor
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THE HOUSE and Senate have both passed bills to deregulate the telecommunications industry; after Labor Day, a conference committee will synthesize a unified bill to send to President Clinton. But the whole idea that telecommunications is a separate, definable "industry" - where the participants compete against each other in a way comparable to how firms compete in the auto industry or the ice cream industry - is highly questionable.

Instead, the "telecommunications industry" is an umbrella term. It covers television, whether provided by broadcast, cable, or home satellite dish. It covers radio. It covers phone service, whether provided by copper wire, fiber optic cable, a wireless technology or some combination, and whether it is local or long-distance.

These methods of communication compete partly with each other, and partly with other industries. For example, television can be viewed as part of the home-screen entertainment industry, which competes with rental movies, video games and parts of the Internet. TV, radio, certain phone services and the Internet provide news and information, which mean they compete with newspapers, magazines and each other. Voice and computer communications over phone lines handle a certain amount of retail sales business, which means competing with shopping malls, stockbrokers, travel agents and others.

The boundaries and relationships between these areas are continually shifting, as new hardware, software and marketing combine to improve existing services and to create new industries, and as companies announce strategic alliances, partnerships and mergers.

In a situation as tumultuous and volatile as telecommunications, it's not clear how to define the market clearly. This poses a problem, because if you can't define a market properly, you can't determine how much competition exists.

In a famous 1956 court case, for example, the Du Pont company was accused of monopolizing the market for cellophane. Its defense was that cellophane was just part of a larger market for "flexible wrapping paper," and so even if Du Pont controlled almost all cellophane sales, it faced considerable competition in the wrapping paper market. The Supreme Court agreed with that defense.

The telecommunications deregulation bills are based on the notion that if we look at the players in telecommunications one at a time - for example, separating cable TV, broadcast TV, local phone service and long-distance - we are committing "the cellophane fallacy." That is, we're focusing on a narrow slice, rather than on the larger relevant market.

Thus, the deregulation bills would break down the barriers between the different players in the budding telecommunications industry. Cable TV and long-distance companies could provide local phone service. Local phone companies could compete in the long-distance market, albeit under certain restrictions. In rural areas, local phone companies could buy local cable systems. In the Senate bill, electric utilities could provide phone and cable services.

The current restrictions on one company owning only a limited number of radio stations would be eliminated, while the restrictions on owning a number of TV stations would be loosened. The House would also allow a single company to combine TV, radio, cable and newspaper operations in various ways.

Finally, both the House and Senate bills would deregulate the rates of small cable TV systems immediately and move toward deregulating the rates of larger ones.

This brief description should illustrate that these bills aren't about deregulating an existing industry. Instead, these bills embody the hope and belief that it is becoming technologically feasible for a group of companies that haven't traditionally competed against each other to begin doing so.

Yet the ultimate shape of competition in telecommunications remains unclear. Who can know what technologies will exist? What products will be invented? What people will like best? Or how the most efficient companies will be structured?

Since the boundaries of the several markets that overlap with telecommunications are so muddled, it's impossible to know what sort of industrial structure and government regulation will be in the long-term national interest. However, a general guideline is that deregulation only works, whether in telecommunications or any other industry, when sufficient competition exists within the relevant market.

My guess is that there is plenty of competition for providing the content of what is broadcast and communicated. In this area, it makes sense for government to set technical standards that encourage open competition, and then to step back and let competition flow.

However, for intensive two-way communication, most homes and businesses still depend in some way on a hook-up to their local Baby Bell phone company. It makes sense to explore the possibility of developing alternative connections, perhaps through the cable TV lines, or wireless technologies, or alternative sets of lines. But until users have as much choice in their local telecommunications hookup as they do in their long-distance phone service or their airline tickets, some continued government regulation will be necessary.

By and large, the telecommunications bills are a reasonable step toward a substantial prize. President Clinton's Council of Economic Advisers has estimated that an ideal telecommunications reform, by improving the information flow throughout the economy, could add $100 billion to economic growth over the next decade.

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