Economic Model for Monopoly Analysis

¶ … Economic Model for Monopoly Analysis in Telecommunication:

Proposal to demonstrate Uniqueness. Mathematical Economic Model.

The Telecommunications Act of 1996 sought to end the monopoly that once existed in the telecommunications industry. Since its adoption, the telecommunications industry has been undergoing a period of rapid change and development. The entry of new players into the market encouraged them to seek new ways to attract and keep customers. These changes have led to a rapid influx of new technology and services.

Many times what defines a monopoly is not clear in every circumstance and there are many pending lawsuits for violations of Anti-trust laws in the courts today. Economic models are useful in resolving issues of whether a monopoly truly exists, or whether claims are unsubstantiated. Previous models were applicable only in certain situations. These models are unreliable in predicting monopolies outside the parameters for which they were designed. This research will evaluate and analyze economic models that could accurately predict the existence of a monopoly in the Telecommunications sector.

Introduction

Rationale for Study

Scope of Problem

Statement of Hypothesis and Research Questions

Literature Review

Methodology

Sample Population

Data Analysis

Findings

Conclusion

Introduction

Monopolies have been the subject of large amounts of media attention in recent years. Recently, there has been the question of whether Bill Gates constituted a monopoly, or whether his vast empire was a just and fair reward for good business savvy. There have been many questions regarding mergers and acquisitions of corporate giants would create a monopolistic environment, this creating an unfair advantage and virtually destroying any smaller companies that were unable to compete on their scale. Courts are flooded with cases such as these and surrounding all of these cases is one key question, "What exactly is a monopoly?"

Everyone is familiar with the textbook definition of a monopoly, that is, a marketplace where a lack of competition exists and one company controls all or a significant portion of the market place. A monopoly is only good for one entity, the monopoly itself. A lack of sufficient competition allows them to set their own prices and in some cases, no incentive to produce the best quality product available. If the product or service that the monopoly produces is necessary for life, then the customer has only one choice. They must take the product that is offered, and pay the price that is offered, especially if there is a lack of a sufficient substitute product.

Monopolies tend to drive up prices and have many negative effects on the establishment of a fair marketplace. One of the key issues surrounding the court cases regarding monopolies is that there are many different types of monopolies that exist for many different reasons. Some monopolies exist because of scale. In this case, the monopoly simply out-produces anyone else in the industry. They are price makers and everyone else must follow their lead. Because of their size, they can often produce goods cheaper than their competition and there fore can offer them at lower prices. Eventually, the smaller companies may be forced out of business and a true monopoly then exists.

Some monopolies exist due to location. This is particularly common in the telecommunications sector and other utility sectors. There may only be one service provider established in an area and the product may be necessary to life. Therefore a monopoly exists due to location. There are other more subtle forms and reasons for a monopoly existing, such as the effect that at a provider is the first to offer a service. They establish brand equity and name recognition. This may make entry into the market more difficult for the competition.

Monopolies may be complete, where the monopoly is the only provider and has complete control over the marketplace. The monopoly may be partial, where there is competition, but the monopoly retains a significantly large portion of the marketplace. A monopoly makes it difficult to enter into the marketplace. The more complete, the monopoly, the more difficult, entry into the market will be. However, in an incomplete monopoly, it is possible for the monopoly to drive prices up and consequently allow a lower priced competitor to steal a portion of the marketshare from the monopoly.

As one can see, there is not one hard and true definition of what constitutes a monopoly. The term "monopoly" has many shades and subtleties that make a hard definition a difficult task. There have been many mathematical economic models that have attempted to provide a legal definition by which the courts, businesses, and general public could use to classify whether a market is a monopoly or not. If this clear-cut definition existed, the courts would not be bogged with Anti-trust suits; there would be no argument. This is the purpose for the following research. This research will focus on the telecommunications industry and will examine models and their potential applications that will be useful in determining if a monopoly exists in the telecommunications industry. This model will be tested through empirical research.

Rationale for Study

Recent focus in the telecommunications industry has been on the cell phone sector and other new technologies such as broadband communication and other wireless services. However, the predecessor to this expansion in the telecommunications industry began with the Telecommunications Act of 1996. When this act was passed, there were eight major players who offered local telephone service: GTE and the seven "Baby Bells," the operating companies spun off from the old AT&T -- and five significant long-distance companies -- AT&T, MCI, Sprint, LDS WorldCom and Qwest. In only three years, these thirteen companies have merged into five telecommunications giants, in a series of record-breaking merger deals (McGaughlin, 1999).

With the aggressive deregulation in the telecommunications industry in the United States and Europe during the early to mid-1990's, it seemed that the local monopolies would be forced to unbundle their networks. However, MCI WorldCom, the second largest U.S. long distance telecommunications company, announced in October 1999, that it would acquire Sprint, the third largest U.S. long distance company, in the biggest corporate takeover in history to this time. The merger was valued at $129 billion in cash, stock and debt, making the new entity second only to AT&T in the U.S. telecommunications industry, a company with, as of 1999, $65 billion in annual revenue, 142,000 workers and 40 million business and residential customers (McGaughlin, 1999).

MCI WorldCom itself was formed from a $40 billion merger in 1998. It then outbid BellSouth to acquire Sprint. After reports began to surface of a combination of MCI WorldCom and Sprint, BellSouth jumped in with a $100 billion hostile takeover. This move compelled MCI WorldCom chief Bernard Ebbers to raise his offer to $115 billion in cash. This offer included $76 for each Sprint share, plus an additional $14 billion in stock, debt and deferred payments.

The enormous size of the combined company demonstrates the increasing monopolization of the telecommunications industry, nearly twenty years after the court-ordered breakup of the old AT&T monopoly. Since then, AT&T had 43% of the long distance market and the new MCI WorldCom-Sprint will have 37%, giving the two companies effective control (McGaughlin, 1999). As the landscape continued to evolve within the industry, more recently, SBC and Verizon both controlled greater than one third of the access in America. During the same time, SBC/Ameritech was hit with more than $1 billion in fines and penalties for a series of charges of anti-competitive behaviors over a six-year period. (Spiwak, 2002).

The passage of the Telecommunications Deregulation Act in 1996, with the bipartisan support of the Republican-controlled Congress and the Clinton administration, claimed that this law -- for which the telecommunications industry spent tens of millions in lobbying fees and campaign contributions -- would promote competition and lower costs to consumers. The result has been questionable. A major provision of the deregulation bill was to remove legal barriers to local and long distance phone companies acquiring each other, and the results were immediate and massive.

LDS WorldCom acquired MCI and now has acquired Sprint. Three of the Baby Bells -- Southwestern Bell, Pacific Telesis and Ameritech -- have been combined to form SBC Corp. Two more Baby Bells, Bell Atlantic and NYNEX, merged, and the new Bell Atlantic acquired GTE. Qwest acquired the smallest Baby Bell, U.S. West, and is now expected to merge with BellSouth, the last remaining independent Baby Bell, after BellSouth's failure to acquire Sprint. Meanwhile AT&T, which retains the lion's share of the long distance market, acquired two huge cable television and Internet access companies, TCI and MediaOne, as well as McCaw Communications, a leading cellular phone company. In each of these mergers, a vast corporate restructuring has followed in which telecommunications workers paid the price of consolidation through the loss of tens of thousands of jobs. The deal between MCI WorldCom and Sprint will be no different. Ebbers estimated that operating cost savings of $1.9 billion would be achievable by 2001, rising to $3.0 billion by 2004 -- figures which translate into the elimination of at least 20,000 to 30,000 jobs (McGaughlin, 1999).

The deal was immediately criticized as anti-competitive by William Kennard, the chairman of the Federal Communications Commission, and by the Communications Workers of America, which represents some workers at both of the merged companies. But neither government regulators nor union bureaucrats will have the slightest impact on the latest merger. They have neither the power nor the desire to oppose the plans of the giant telecommunications monopolies. More substantial opposition to the merger exists among the overseas rivals of the huge American firms. Deutsche Telekom and France Telecom, the semi-privatized telecommunications companies of Germany and France, each owned 10% shares of Sprint, and Deutsche Telekom at one point sought to enter the bidding to acquire the entire company. Now both European firms will sell their holdings because MCI WorldCom is in competition with them in the European market. It is the second time that WorldCom chief Ebbers has spiked an attempt by European telecommunications companies to break into the U.S. market, following last year's contest between WorldCom and British Telecom to take over MCI. British Telecom has since formed an alliance with AT&T (McGaughlin, 1999).

It was also the second defeat for Deutsche Telekom in two months, after its failed effort to merge with Telecom Italia, whose board of directors accepted a rival bid from the much smaller Italian firm Olivetti, preventing the formation of a German-Italian telecommunications giant with a dominant position on the continent. Ebbers was able to use the then vastly inflated value of American stocks as a weapon in this competitive struggle against foreign rivals. A former basketball coach and motel operator, Ebbers took over LDDS, a small long distance provider based in Jackson, Mississippi, over a dozen years ago, and used it as the basis for more than 60 takeover bids, all of them utilizing complex stock swaps made possible by the booming U.S. stock market (McGaughlin, 1999).

The increasing scale of mergers and takeovers is a characteristic not only of the telecommunications industry but of world capitalism as a whole. Of the 10 largest mergers in U.S. corporate history, all 10 have taken place within the last ten years. But even this record pace has been dwarfed by the merger and acquisition activity in Europe. In the first nine months of 1999, total worldwide mergers and acquisitions hit a record $2.2 trillion, 16% above the figure for the year-earlier period. Mergers and acquisitions in the third quarter alone were $780.9 billion, up 45.8% from the year before. European merger activity in the third quarter accounted for nearly half, $374.6 billion, triple the figure of a year earlier and exceeding the $322 billion in mergers among U.S.-based companies (McGaughlin, 1999).

Since the enactment of the Telecommunications Deregulation Act in 1996, the players in the telecommunications industry have continued to form alliances akin to monopolies, thereby hampering the efforts to deregulate and encourage additional competition in the telecommunications industry. Keeping the fact in mind that in 1996 there were eight major U.S. companies providing local telephone service, and five significant long-distance companies, in only three years these thirteen companies merged into five telecommunications giants and this trend continues to this day. The concern over monopolies grows ever more intense. Overseas telecommunications firms are especially anxious to improve the level of competition and the access that they have to other segments of the consumer population. Additionally, current customers of the larger firms would like to see the savings that competition would ultimately bring.

One of the contributing factors to the flavor of this industry is that market entry as a primary competitor is expensive and difficult, with regulatory hurdles and heavy startup costs paving the way. This strengthens the position of the current stakeholders and provides an environment in which the bells can retain and maximize the lion's share of the market. More recently, the Consumers Union and the Consumer Federation of America attempted to block the 2004 AT&T Wireless/Cingular merger, which represented the combination of the country's second and third biggest cell phone firms. (Note: Cingular is owned by two of the largest bells: SBC and BellSouth.) The petition filed with the FCC claimed: "This merger proposes an unacceptable level of concentration at the nation level, clearly in violation of the merger guidelines, but the anti-competitive effects this merger will have on local markets is of even greater concern." (Murray, 2004)

Prior to 1996, as others began to wish to enter the marketplace, they found it difficult or nearly impossible to compete with the giants. This scenario was not conducive to the ideals of free enterprise and true capitalism, so the government decided to act. They passed the Telecommunications Act of 1996, which de-regulated the industry and paved the way for open competition. The act included provisions for helping new companies enter the marketplace including providing extra licenses in many areas and funding sources for new business startups. This created a wealth of opportunity for new businesses. In an attempt to out-compete their competition, companies experimented with new services, pricing schemes and eventually, new technology. This created a boom in new technology and led to the invention of cell phones, pagers, and other wireless products. Two things were happening consecutively: the major industry competitors were increasing market share and decreasing the number of overall larger competitors using mergers and acquisitions as a vehicle. Secondly, innovation and technology allowed for a new set of entrants to the market; smaller companies that provided goods and services which would bolster and broaden the telecommunications industry as a whole as well as its fundamental composition.

As in other sectors, the privatization of the telecommunications industry has led to a plethora of business startups. Some of them became shining stars and rose to the top quickly, while others crashed and burned. As in any other industry that experiences this type of boom, there were many allegations of mergers and shining stars becoming monopolistic in nature. This led to a backlog of court cases that is likely to be there for some time in the future.

The Telecommunications Act of 1996 sought to end the monopolies that existed in the telecommunications industry. Since the passing of that act, the telecommunications industry has seen a great deal of change and development, including entry of new companies into the market. The changes in the industry have opened the floodgates to new technology and services.

As previously stated, what constitutes a monopoly in one geographic and/or socioeconomic area, may not hold true for another area. Therefore it is imperative to evaluate and identify useful economic models to test for the existence of a monopoly, given the inputs and variables generic to the industry. What defines a monopoly is not an exact science, and is not clear in every circumstance. There are numerous pending lawsuits for violations of Anti-trust laws in the courts today. Economic models are useful in resolving issues of whether or not a monopoly in fact exists. Each model is applicable only given a certain scenario. A model is unreliable in screening for a monopoly if applied to a set of facts outside the parameters for which it was designed.

An economic model is really a set of decision-making devices, organizational arrangements, and rules for allocating society's scarce resources. Some economic models are very simplistic. For example, a Robinson Crusoe economy is a simplistic economic model. The models can also be quite complex -- as the everyday decisions of the 5 billion people in the world, the interactions between all firms in all countries, and the actions of all governments. The traditional approach to economic modeling is geared towards obtaining an equilibrium solution. This involves solving the maximization problems of all agents to yield market-clearing prices. Markets clear when demand is equal to supply for all goods, and also the quantities that are exchanged at these particular prices. One assumption imposed for analytic tractability that rarely captures the economic phenomenon we observe is homogeneity of agents (Yuret, 1998). Relaxing this assumption is not possible in a lot of economic models and, if it can be relaxed, the level of heterogeneity that can be modeled is still very restricted. Moreover, equilibrium solutions are not always very informative for policy purposes. For policy makers, the path to equilibrium is just as important as the equilibrium itself.

An economic model that tests for the existence of a monopoly in the telecommunications industry would be of great use in determining if a monopoly truly exists, or of the claims are unsubstantiated. This research will examine several existing models for the existence of monopolies. There are many instances in which these existing models reliably predict the existence or nonexistence of a monopoly. However, they were developed for prediction under certain types of markets and market conditions. As a result they are reliable in predicting monopolies in certain sectors of the market, however, prove themselves to be inadequate in predicting monopolies in other sectors.

The existing models do work in certain circumstances. However, their inability to work in other circumstances has left some cases, particularly that of the telecommunications field, in a predicament where no clear decisions can be reached. There are still some who argue that the Telecommunications Act of 1996 was unnecessary because no true monopoly existed.

Every sector of the market has its own set of characteristics. For instance, some are cyclical, such as retail, and some are steady growth, as in the case of many manufacturing sectors. Some sectors have many small players, while others are made of a few larger players. Sometimes one company is the clear leader. Sometimes there is a group who emerges ahead of the pack and sometimes all are on a level field. These varying characteristics make it necessary to develop a separate economic model for each sector or sub-sector in the market.

The telecommunications sector is has undergone a complete restructuring and is still in a period of rapid change. The most drastic change came after the adoption of the Telecommunications act of 1996. However, this is a rapidly changing industry and there are many more changes to come. Some contest that even though there are more companies in competition, that there is still a monopoly, or an environment closely resembling a monopoly. This is particularly true in the case of companies such as Lucent Technologies and AT & T. Mergers Such as Viacom, Worldcom and Cingular, among others, draw even more suspicion as they form conglomerates large enough to force smaller companies out of business, by their shear scale. This is the rationale behind the need for the proposed research.

Scope of Problem

The telecommunications sector has been a leader in the technology sector since the influx of new companies and new technologies that resulted in the invention and proliferation of technology after the adoption of the Telecommunications Act of 1996. Anti-trust lawsuits have caused many disruptions in the development of the sector and as a result caused massive overheads for companies that could barely afford it. Many of these lawsuits have centered on the existence of local or large monopolies. These lawsuits lowered the profitability of many companies and forced many of them to go bankrupt pr make drastic cuts in their workforce. The costs of these lawsuits have been devastating and have hurt the profitability of many companies. As a result, the sector, as a whole, has suffered an evolution that will likely take some time to settle.

Statement of Hypothesis and Research Questions

The focus of this research will involve the examination and evaluation of mathematical economic models that can accurately predict the existence of a monopoly in the telecommunications industry. This model will be useful in predicting the existence of a monopoly in the Telecommunications industry, becoming a useful tool in resolving the issue of whether a monopoly exists or not.

While many economic models have been developed in this vein, their applicability to this rapidly evolving industry is questionable given their parameters and constraints. We will work to identify the models that are best suited to incorporate the characteristics of the industry and the outside factors that effect supply and demand, growth, price and competition.

Literature Review

Much literature exists on the telecommunications industry and the history of the Telecommunications Act of 1996. There is a wealth of scholarly debates regarding whether it has been a help or whether it has been of harm to the industry. It can be debated as to which side holds the most truth at the present time. The following will review the current literature available, both on the telecommunications industry and the models that have been used to describe other monopoly models. The review will be critical in nature and will attempt to summarize as much of the information as possible on the topics at hand.

The Telecommunications Industry

The telecommunications industry is important and considered a vital part of our everyday lives. The telecommunications industry represents only a small portion of the country's Gross Domestic Product, only 1-2% (Stigiltz, 1998). While this amount may seem insignificant, the services that it provides are vital to every other sector in the economy. Telecommunications is the backbone of many other sectors.

The Telecommunications Act of 1996 is one of the most highly debated topics in economics. There are some that say that it has been ineffective and that we now have a monopoly again, as a result of mergers and acquisitions. There are others who say that it has had the intended result, but that the movement towards a competitive marketplace does not happen overnight. Poulson (1997) believes that achieving a fair market in Colorado will not be immediate and will take some time. There are others who believe that it is working in some cases and not working in others. Alaska is moving towards a more competitive marketplace on a local level. Rural communities often have a localized monopoly as there are not enough customers to attract competition (APUC, 1997).

Michael Porter states that "Paradoxically, the enduring competitive advantages in a global economy lie increasingly in local things - knowledge, relationships, and motivation that distant rivals cannot match (Porter, 1998). He is referring to what is known as clusters, which he defines as one place of unusual competitive success in particular fields. Examples of clusters can be found across industries and around the globe. Examples of clusters include Silicon Valley, Hollywood, the California Wine Valley and the Italian Leather Fashion sector.

Clusters can be characterized by the interconnected network of suppliers, service providers and producers who are geographically aligned and who have positive dependencies and cooperation with one another. Alfred Marshall's Principles of Economics points out that location-based clusters that conduct specific types of business and economic activities form based on the sharing of "tacit" knowledge among business participants. (Krugman, 1991) The success of a cluster depends not only on what operating strategy firms employ, but also on the surrounding business environment. Clusters differ from the traditional definition of a monopoly in that competition and cooperation are vital to the success of the business. According to Porter, there are three overarching ways that clusters influence competition:

Productivity of companies is increased by the dynamics of a cluster.

Clusters tend to direct the pace of innovation through competition and cooperation.

Clusters actually support the growth of new business - each individual business can benefit from the scale of the cluster.

The Cluster Mapping Project conducted by the Harvard University Business School's Institute for Strategy and Competitiveness, identified and visually illustrated various clusters in America: from the auto industry in Detroit to the financial sector in New York.

Many have made predictions, similar to the one that will be made by this research project. Many of these feel that the telecommunications market in 2010 will be a pure competition, with no single company emerging as the dominant force. Pehal (2000) believes that the market in 2010 will not be dominated by one type of technology and that the result will be a mixture of the new and the familiar. Powers, and associates (2000) predict a similar scenario. Others see the market moving towards a monopolistic setting in the future (Farrell, 1995, Goldstein, 1993, Kanell, 1998, Kitmari, 1998, and others). They are basing these claims on the fact that some companies are now beginning to emerge as monopolies at the current time. Sun is currently being accused of attempting to gain a monopoly of scale (Malik, 1999).

Monopolies have many negative effects on the marketplace. Monopolies prevent competition and raises barriers of entry into a market. Senator Leahy points out that the cable television companies are a prime example of this. (Kenyon, et. al., 1995). A free and open competition ensure that customers will have many benefits, such as lower prices, a variety of new and developing products and services. A competitive market forces companies to strive to maintain a customer base, whereas a monopoly promotes routine and is resistant to change. In a free competition, businesses must strive to provide customers with new and innovative products at reasonable prices or face the loss of customers and declining profits (FCC, 1995). It is the customer and society as a whole that benefits from free competition.

A natural monopoly exists when the people in an area need a service or product to sustain their daily lives and there is no product substitution (Stoffels, 1999). It also exists where there is no other close competition, due to the fat that there is a lack of resources for expansion into the area. A prime example of this is a rural electric cooperative. Usually the one who ran the lines first can have a monopoly. The people will use whoever is there and have no other choice. It is unlikely that another company will run lines to the same locations due to the cost involved and the uncertainty that customers will switch. Gasmi, et. al., (1999) developed a test for a natural monopoly that he feels would be applicable to the telecommunications industry. It was developed to determine natural monopolies in the rural electricity industry. Upon examination of the test, it was felt that it would be useful in certain sectors of the telecommunications industry, especially where rural hardwire telephones were involved. However, it did not appear that it would be useful in other segments of the market, such as cell phones and other wireless products, or in urban areas.

A duopoly exists where there are two companies that compete in a marketplace. In this case, there is limited competition, but no clear competitors exist, other than the two duopolists there are some that many consider this situation to be a small oligopoly. In this case, the two competitors must match each other in price and quality. One cannot afford to fail to match the other's price. This market can be good for the monopolists, if cooperation exists between them. However, if they are fierce competitors, the competition will serve to harm both, as they strive to lower prices and out-perform one another. Pociask and Rutner (2000) believe that a separate test must be applied when analyzing a monopoly vs. A duopoly.

Huisman, (2000) explored that benefits and effects that a monopoly will have on the marketplace. Huisman draws the conclusion that the long-distance market is currently an extremely concentrated market, increased by the bevy of mergers and acquisitions in recent years. Some feel that this configuration will make it even harder to compete for smaller companies.

Huisman argues that entry into the marketplace is currently high. The established companies have a considerable amount of brand equity attached to their names. It would take a massive and very expensive media campaign to compete with MCI Worldcom and Sprint. There is a certain amount of trust associated with a name. People will not be likely to switch to a small, barely known carrier, even if their prices are substantially lower. There are also considerable regulatory and capital expense barriers that make it nearly impossible to enter into the market. These factors tend to weaken the opinions of those who claim that the advent of MCI Worldcom, Sprint, Cingular and AT&T do not resemble a monopoly, or a strong duopoly. These carriers are able to meet future demands of a growing client base, therefore it seems unlikely that the current situation will change (Huisman, 2000).

Huisman argued that the MCI Worldcom/Sprint merger should not be allowed, as this will create a true monopoly in the telecommunications industry. As long as the two remain separate, there is at least a limited amount of competition. He feels that a limited amount of competition is better than allowing this market to become a pure monopoly. These two companies have cornered the market on an economy of scale and it would not be possible to retain efficiency in any other way. This is the case in the long-distance area of the market. However, Huisman feels that the merger would be beneficial in other markets such as in the wireless and local exchange services. The merger would provide better interconnectivity. However, there is still a concern that this would create a smaller competitive market in these areas as well.

Huisman is clearly against a further concentration in the Telecommunications marketplace and argues that re-creates the same situation that the Telecommunications Act of 1996 sought to prevent. Huisman suggests that a strong campaign be launched to convince the government to dis-allow the conglomerate mergers. However, he feels that this is not enough and calls for a divestiture of Sprint's equipment and backbone to allow others to enter into the marketplace. He feels that the Telecommunications Act of 1996 was necessary and that the intentions were good. However, since its adoption, the market has been allowed to develop with no guidance or intervention and that this has created a market similar to that which existed prior to the Telecommunications Act of 1996. He notes that the Worldcom merger, for instance, effectively eliminates the two companies who currently have a chance to pose competition to the impending "supergiant," Bell Atlantic and GTE. His point-of-view at this time was that, due to a lack of maintenance, it would seem that we have taken a step backward and that it is "Ma Bell" all over again (Huisman, 2000).

Economic Models of a Monopoly

As one can see, the telecommunications industry is a complex entity and there are industries within the industry. The industry has gone from a relatively pure monopoly to an attempted competition, and now it is questionable as to whether it is gravitating towards a monopoly again. In addition, there are now more products and services available. The market is no longer comprised of one market. There is a long-distance market, a local service market, and a cell phone and wireless market. All of these markets have different characteristics and the previously existing models fail to useful in all areas of the telecommunications industry. For instance, the Gasmi Model (Gasmi, et. al., 1999) is useful in the rural local phone service industry in rural areas. However, is very ineffective in prediction in an urban market, where there are many competitors, such as the cell phone market. In this market, there may still be a monopoly. However, the monopoly does not have as much power as in a natural monopoly setting.

The Bureau of Census measures industry concentration for major Standard Industrial Classifications (SICs) by calculating a concentration ratio (CR). The CR identifies the industry's 4, 8, 25 and 50 largest firms based on percent of market share. The higher the ratio, the greater the market share (indicating a possible monopoly). Conversely, a low ratio would indicate a larger number of competitors. Of course, market share is one piece of a puzzle when evaluating an industry. An industry that is characterized as disciplined, for instance, indicates that there is a low level of rivalry among competitors. Many factors contribute to increased competitiveness among like firms: as previously illustrated, for instance, a low CR ratio indicates more competitors who are likely to compete for greater market share. Slow economic growth also means competitors must work harder for a piece of diminishing pie. Given that the "all things being equal" premise is limited, Porter and Schumpeter have shifted from the ideal of a static model to understanding the dynamic nature of influencing forces and their related interdependencies with Porter's "Five Forces Model." Their underlying premise is that innovation drives market dynamics. This can be seen in the evolution of the telecommunications industry as new products, technologies and supporting services have entered the marketplace.

Porter's "Five Forces Model" takes into account the landscape of suppliers, producers, buyers, and competitors within a specific industry. He points to five forces that are determinants of pure competition and profitability within a given industry. According to Porter, "the model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries." (Porter, 1998) This is one possible flaw in the underlying rationale: it is a scenario that assumes an all things equal stance, which does not mirror market conditions in real life. Nonetheless, the model can be useful in providing insight to the environmental context and structure in which a competitor operates, and how these factors can influence the outcomes. The following diagram illustrates the five forces and how they are inter-related.

Each force has distinguishing characteristics that when combined can influence the firm's potential profitability and competitive stance. The first force, Suppliers, can be measured by the concentration of suppliers in a given region, the volume levels of the supplier, the types of inputs to the supplier and their effect on cost or differentiation, and the presence or absence of substitute inputs. Greater availability of substitute products, for instance, increases elasticity of demand because customers have greater choices. Price changes in substitute products influence the level of elasticity.

Porter states that, when consumer purchasing power is strong, the industry relation can be classified as a monopsony, i.e., a market characterized by many suppliers and one buyer. While the existence of pure monopsonies is scarce, there is a correlation between buyer power and industry position. With regard to potential new entrants to the market, increased competitors spur rivalry. In an ideal setting firms should be able to enter and exit markets freely and profit margins would be nominal. Yet barriers to entry exceed normal equilibrium adjustments typical of markets; they are unique characteristics of an industry such as high start up costs and heavy regulatory requirements, as in the case of the telecommunications sector. In addition, economies of scale within an organization can create a barrier to entry for new firms. The MES, Minimum Efficient Scale, measures the point at which production costs are minimized. Knowing this measure can help estimate the amount of market share necessary for entry. Porter notes that in the long distance communications sector, 10% of the market is necessary to attain MES and to remain competitive. Industries with a high MES, then, make it difficult for smaller start ups to enter the fray.

Strategies can be employed by companies to counter the effects of one or more of the five forces: from a business perspective, industry rivalry can be addressed using strategies involving cost leadership, differentiation, and focus to try and gain competitive advantage. The strategy employed by a competing firm should be designed to capitalize on its strength while countering any adverse effects of any of the five forces and how they impact the organization's opportunity to compete in the marketplace.

An Agent-Based Economic Model

An agent-based economic model is one in which the decision-making processes of the agents is in an economy with one product market, and two input markets, with the two input markets being capital and labor. Firms interact with the three markets. There is a special firm, namely the state-owned enterprise (SOE). Obviously the SOE has different constraints and must follow different protocol than the rest of the firms. All firms, including the SOE produce identical products, for purposed of the model. In the model, consumer agents are not explicitly modeled, but rather specific input supply functions and an output demand function is imposed. This model can be solved analytically if firm agents are assumed to be homogeneous. All of the functions are differentiable, so the solution involves simultaneously solving the equilibrium conditions and all the first order conditions to the maximization problems, to get market-clearing prices and quantities. However, heterogeneous agents are a defining component of transition economies so this simplification would rob the simulation of all potential interest (Yuret, 1998). By applying the economic model to current telecommunications factors, one is able to identify where equilibrium does not exist.

Telecommunications market structure, development, and impact studies broad-based analysis of the underlying economic structure of national or state telecommunications markets is possible and necessary. This analysis includes such measures as competitive potential, growth and expansion opportunities, service maturity and evolution. Studies include fundamental cost and demand characteristics of existing and emerging markets, service substitutability, and macro-economic factors such as impacts of restructuring, changing demographics, income and trade variations. Economic models employed include: macro-industry, as well as sector and service specific cost and demand models (Townsend, 2001).

Demand analysis and forecasting studies, modeling

Analysis of present and prospective demand for various communications services in different markets, and under alternative economic assumptions. This type of study combines primary research such as survey and empirical analysis, with cross-reference data from prior experience or other markets. The studies can focus on a specific new service introduction, or prospects for market growth and expansion across broad industry segments. These studies also typically incorporate one or more Economic Models, which can include estimates of income and price elasticity, impact of economic changes, and comparative demand data.

Service and Network Cost Studies and Models

Analytical studies and research into the cost structure of telecommunications networks, operators, and specific services in various markets. Based upon empirical data and comparative results, as well as review of alternative cost studies, these projects examine such factors as: long-run incremental costs (LRIC) of individual services; economies of scale and scope for integrated carriers; and market-wide network investment and operating cost characteristics and forecasts. Cost study projects are usually based upon existing or custom-designed Economic Models, as well as review and interpretation of other industry cost models, such as the various Benchmark Cost Models (BCM), and Bellcore cost models (Townsend, 2001).

Comparative tariff, policy, and market analyses

Research studies of comparative prices, regulatory policies, or market conditions across national and international telecommunications markets. Primary research is based upon direct contact with telecom operators and officials in different states or countries, along with review of published data sources. Quantitative comparisons are rendered in relevant terms, such as equivalent currencies and/or purchasing power parities. Comparisons of policies and market conditions also reflect differing economic and political environments. Comparative studies can also involve Economic Models, as for example the Tariff Comparison model, which incorporate calculations of various service elements to render valid statistical comparisons.

Tariff Model -- International Comparisons

The OECD has established a methodology for comparing residential telephone service charges, business service charges, data circuit charges, cellular charges and a number of other services tariffs. The methodology is based on costing out a representative basket of component services and quantities, such as installation, access and call usage, in specified amounts, in each countries currency, and then converting to a common base via the use of 'purchasing power parity exchange rates (PPP) ' [PPP exchange rates are based on comparison across countries of the cost of a representative basket of goods and services - hence the term purchasing power parity.]. While there is scope to argue that the methodology may not properly be representative of users actual cost structures and that the use of PPP exchange rates is problematic, the method never-the-less allows direct comparisons of typical telecommunications services costs between countries (Ministry of Economic Performance, 2001).

OECD Basket Comparisons of Telephone Services Charges - August 1997

Based on the comparative ranking of residential and business telephone services tariffs for OECD countries, (the OECD tariff basket model), New Zealand is ranked 12th in residential and 15th in business, out of 26 countries. It is possible that the OECD model does not adequately factor in discounted tariffs in New Zealand's case and to this extent may not be fully representative of consumer telephone service costs in New Zealand. Most other OECD countries either do not allow tariff discounting or severely limit the practice. Over the last six years the major telecommunications services price reductions have been in the long distance call transport markets, which probably represent some 35% of Telecom's core telecommunications services business by revenue (this would include national and international calls, and the long distance calls component of enhanced services). There has also been a reduction in business access (rental) charges following the introduction of city access rentals in built up business areas.

The Department of Statistics telecommunications services consumer price index (TS-CPI) indicates price changes (in real terms). Notable features are; the real price of toll calls has declined significantly. Since the entry of Clear Communications into the long distance call market in March 1991, real toll prices have reduced on average by some 5.6% per annum (pa);

in the corresponding period the data indicates that the average real telephone access line rental and installation costs increased initially but declined progressively since late 1993;

(However, it should be noted that the real price of standard residential telephone service has not exceeded the November 1989 level, as required by Telecom's Kiwi Share obligations.) the consumers real telecommunications services price index decreased on average by some 2.1% pa over the period;

The indexes are considered to be representative of the prices for basic telecommunications services in the residential telecommunications services markets.

Telecom substantially updated many aspects of its core network infrastructure and associated services in the early 1990s. In recent times Telecom has invested substantially in expansion of its cellular network, information systems to support improved services and reduce cost, Internet service access and cable TV roll out (Ministry of Economic Performance, 2001).

Studies have been conducted on monopolistic markets in other areas. It has been found that monopolies retain certain characteristics and that they are subject to many factors that influence their behavior. Consumers have a set of guidelines, by which they make purchases. Even in a pure monopoly, the company must provide a certain level of perceived quality and cannot engage in overly high pricing schemes. It would seem as if the consumer would have no recourse, especially if they need the product or service. However, disgruntled customers will complain to their government and could pressure the government to break up their monopoly.

Many studies by Shimonura and associates (1197-1198) demonstrated that market equilibrium could be manipulated by placing a set of export constraints on the market (Kemp, M., Okawa, M., Shimonura, K., 1996). Graham, et. al. (1983) studied the airline industry after deregulation. They found that fares are independent of market concentration. Rogerson (1982) found that monopolies seek resources directed at obtaining profit and that there are social costs to the monopoly because of this rent-seeking activity.

A monopoly firm's pricing strategy in a market in which consumers have varying perceptions of the quality of the firm's product. The effect is reflected in the price that the firm will be able to secure for the product (Kehoe, 1996). Caminal (1996) found that a monopoly can choose between no advertising and large-scale advertising. The monopoly will adopt the most efficient advertising strategy in conjunction with lower fixed prices for their services. In a duopoly, when consumers have a fixed time-horizon, such as signing a one-year contract, the two firms may alternately dominate the customer base, alternately charging high and low prices. (To, 1996).

Using a maximum entropy technique, we can approximate the market shares of each firm in an industry using the available government summary statistics such as the four-firm concentration ratio (C4) and the Herfindahl-Hirschmann Index (HHI). This technique is reported to be effective in estimating the distribution of market shares in 20 different industries. Golan et, al (1996) support practice of using HHI rather than C4 as the key explanatory variable in many market power studies (Golan et. al. 1996).

Golan et. al. Presented their technique as a one-size-fits all factor that would be useful and applicable in a variety of situation, citing its usefulness in 20 industries. Upon examination of the technique used, however, it was found that many variables were not taken into account, such as changes in industry structure and the existence of markets within markets, Golan and associates tout their method as being useful in almost any situation. However, it is was not found to have the wide applicability that they claim. Before applying their method, one should be careful to examine the circumstances to which it was originally applied and to be certain that the situation being tested has similar characteristics to those used by Golan and associates.

Golan and associates did apply their method to 20 industries. However, they did not state the conditions in the industry. Generalizations such as these can be dangerous and should be carefully examined when choosing to use the method for one's own analysis. This is not to say that the method is not useful, it certainly has some merit. It is the widespread applicability that is in question in this case, not the method itself.

Lieberskand et. al. (1996) examined the impact of corporate restructuring measured at the industry level on industry concentration in U.S. industries. These industries were engaged in the basic, manufacturing, and services sectors between 1981 and 1989. The results demonstrated a modest increase in median industrial concentration in sample industries between 1981 and 1989. There were few sell-offs of assets at the industry level through horizontal mergers, acquisitions, and inter-firm asset sales increased U.S. industrial concentration during the 1980s. (Lieberskand et.al, 1996).

The Lieberskand study is interesting when one compares the manufacturing industry to the telecommunications industry. The telecommunications industry has undergone a complete restructuring, as compared to the manufacturing industry. The manufacturing industry has been relatively steady, yet still shows a trend toward a higher level of concentration. The manufacturing industry has high barriers to entry, and in many cases, only one of two producers of a particular product. Lieberskand was baffled by the trend towards a more concentrated marketplace in what he considers to be a free competition.

Lieberskand considered the entire manufacturing sector to be a free competition. However, in reality it is a bunch of small natural monopolies. For instance, Colgate/Palmolive make hundreds of consumer products. There are only two or three competitors that manufacture similar products. One of their primary competitors is Proctor and Gamble. They could be considered to be a duopoly. However, a closer examination of the market shares would have to be undertaken. This industry does not have hundreds of competitors. This represents only one product line.

Another example is in the airline industry. There are only two or three major manufacturers of airplanes. Lieberskand made the error in his analysis of considering manufacturing to be one entity. However, it is really a number of smaller entities and this is the factor that confounded Lieberskand's analysis. Lieberskand was confused by his findings and this is explanation that eluded him. Some of these monopolies are natural monopolies. However, most are monopolies of scale.

Economic textbooks have called the telecommunications industry an ideal model of a natural monopoly (Thierer, 1994). However, Theirer points out that this monopoly came into existence with the aid of the U.S. government and that many would-be competitors were excluded and not allowed to obtain licenses in the beginning. As stated before, monopolies are detrimental to the market place by creating higher prices and sometimes-lower quality. Let us examine one possible reason why the government would wish to promote a monopoly.

A natural monopoly can serve consumers at lower costs than two or more firms. This would seem contrary to popular convention until one considers the high barriers to entry into a natural monopoly. Once a single firm overcomes the initial costs, such as laying the cable, or building the sub-stations, their average cost of doing business drops rapidly, relative to newcomers in the industry.

Kellogg, (2000) found that if a monopolist sets their price before they have determined the level of demand for their product, then they have essentially limited the availability of output at lower prices. It cannot lower its prices and this can lead the way for competition and lead to its eventual displacement as a monopoly. Kellogg cautions companies to wait until demand can be determined before setting prices.

Kellogg (2001) examined the homogeneous good Cournot model with two existing companies and one potential entrant into the market. HE demonstrated that entry can occur even if the entrant has no cost advantage and must rely on existing companies to distribute their product. This is exactly what happened in the wireless portion of the telecommunications industry. In the beginning there were only a few companies manufacturing cell phones. The costs to enter this market are high. However, in spite of this, other manufacturers were able to enter the market and there are now a large number of manufacturers in the industry. Some manufacture their phones and sell them under a larger conglomerate name. This gives the larger conglomerate another product line, for which it does not have all of the manufacturing costs and gives the smaller company the advantage of the larger companies brand equity. The Cournot model could prove itself to be highly useful in the development of a model for the telecommunications industry.

The practice described above is called "bundling." Martin (1999) found that bundling be a firm with a monopoly over one product is strategic and that it changes the substitution relationships between the goods. Now the monopoly does not have to worry about the competition as a substitution product. It can now use the product produced by the other company to its advantage. This is a highly profitable proposition for the monopoly. This strategy is usually used by the monopoly to reduce or eliminate competition. In many cases, the larger company will force the smaller company into this arrangement as they can easily override them otherwise.

Labor Unions are not usually considered to be a monopoly. However, there have been many models that prove them to have all of the characteristics of a monopoly. Many models have been developed describing the characteristics of labor unions as being monopolistic in nature. Some of these models may be useful in determining the existence of monopolies in the telecommunications industry because the structure of the labor union is similar to the telecommunications industry.

Labor unions are national in scope, just as with the national telephone carriers. However, they are local in nature as well, small branches serve limited sections of the population. Labor unions engage in a variety of trades, such as plumbing, painting, electricians, etc. They have many products to offer and each of these products represents a different market. This is very similar to the telecommunications industry where there are long-distance markets, local service markets, cell phones, PDA's and other products, all representing a different market. For these reasons, models that are used to describe the labor unions may prove to be the most useful in describing the telecommunications industry.

Currently, there are many models that claim to be the answer in all cases involving the existence of a monopoly. In the models that make these claims, one thing is obvious; they did not compare the market characteristics of the industries for which they have proposed the model. In the case of the telecommunications industry, it was surprising to find that the labor unions were the most similar in structure and market scope. These may be the most useful in constructing a model for conduct of this research.

Many of the models were sound in theory. However, sufficient testing was not performed to substantiate the claims being made. It is not expected that any one of these models will adequately apply to the telecommunications industry. However, in the case of the labor union models, a few modifications may make the most meaningful model. These statements are only speculative at this point and no clear conclusion regarding the methodology can be proposed at this time.

The literature on the telecommunications industry has to this point, focused on the effects of the Telecommunications Act of 1996. There are as many reports that state that the act created a competitive marketplace. Research has shown that this may have been true, at least for a while. However, it is possible that the marketplace may be changing to a monopolistic model in the near future, especially with the upcoming proposed merger between MCI Worldcom and Sprint.

Methodology

This research will be conducted in two phases, to be discussed in detail in the remainder of this section. The first phase of research involves a detailed review of the Telecommunications industry, both historically and in present times. Existing methodologies for determining the existence of monopolies will be explored in detail and compared to the needs of the telecommunication industry. We will then apply metrics form the telecommunications industry both prior to and following the Telecommunications Act of 1996.

The first section of this research involves evaluating the model and is applicability to the industry by design. This will involve a detailed study of existing models and how they apply to the circumstances for which they were originally developed. These models will then be studied to determine if they would be useful in the telecommunications industry. Unique factors in the telecommunication industry will be identified and worked into the equation. The model in this research will serve as the research instrument.

If the model reacts as planned it would be expected that the model will show strong evidence for the existence of a monopoly. The model will be tested after the adoption of the Telecommunications Act of 1996, where it should not show strong evidence for the existence of a monopoly. A variety of tests will be conducted in more recent times where the existence of a monopoly is questionable. If the results obtained fail to make the expected results, then the model will be reexamined and adjusted. The tests will be repeated until the desired results are obtained and found to be statistically significant.

Sample Population

The sample population for this study will be various sub-sectors of the telecommunications sector over the period of time from 1995 through 2002. This will cover the time both before and after the Telecommunications Act of 1996. It is not believed from historical literature examined that going farther back than 1995 will produce significant results, as the market remained relatively unchanged until this time.

According to Bureau of Labor Statistics data, approximately 2% of all consumer spending is devoted to telephone service, a statistic that has been static during the past fifteen years, although average annual expenditures on telephone service went from $375 per household in 1982 to $956 in 2003.

Wireline

Telecom carriers are required by the FCC to report the number of lines in services and wireless subscription stats. As of December, 2004, carriers with a minimum of 10,000 switched access lines or 10,000 mobile subscribers were required to report. According to the data submitted, incumbent local exchange carriers (ILEC) provided 145.1 million switched access lines, as opposed to 32.9 million for competitive local exchange carriers (CLEC). CLEC lines increased 3% during the second half of 2004. In addition, CLECs comprised 18.5% of the access line composition as opposed to 17.8% six months prior. (Eisner, 2004)

Wireless

In September of 2005, the FCC released its Annual Report on the State of Competition in the Wireless Industry. The report reflects marketplace conditions at the end of 2004 by taking into account market structure, carrier conduct, consumer behavior and market performance to measure competitiveness. Based on FCC findings, regardless of the recent wave of mergers, it concluded that the wireless sector of the market remains competitive in nature due to the following factors:

97% of the total U.S. population resides in counties with three or more providers

93% live in counties with four or more providers

87% live in counties with five or more providers

The report further notes that this composition is relatively unchanged from the prior year. In addition, the carrier conduct indicates strong pricing competition, with 6% of subscribers of prepaid plans in 2003 growing to 8-11% in 2004. Innovation continues to spur industry growth in this sector as well, with carriers investing in CDMA 1 xEV-DO networks that increase download speeds for consumers.

As for consumer behavior, when local number portability (LNP) was enacted in November of 2003, consumer costs were reduced by being able to retain their local numbers while switching carriers. An industry measure called churn reflects the percent of customers who switch carriers. This metric averaged 1.5% - 3% per month in 2004, a small reduction from the previous year.

Market performance indicators also point to competitive influences: the number of subscribers went from 160.6 million to 184.7 million during 2004. The Cellular CPI declined 1.0% during 2004 (as opposed to 2.7percent overall), indicating price savings for consumers. The average minutes of use per month as well as the volume of text messaging also grew significantly during this time. (Martin, 2005)

Data Analysis

The first portion of data analysis will be to determine if, when the model is applied, a monopoly is found to exist. Some may be considered to be partial monopolies. These will be treated as a monopoly for purposes of this study. This data will be analyzed and scatter-plotted according to time to determine if more or less monopolies come into existence over a long period of time. Patterns in this data are expected to reveal trends in the formations of monopolies over a period of time. Trends in the movement towards a monopoly or towards a more even competition are expected to be revealed by this analysis, which will be used to attempt to predict future trends in the formation of monopolies in the telecommunications sector in the future.