Antitrust's Real Legacy
Eighteen months ago, United Airlines and US Airways were both so strong, apparently, that by combining forces they would have acquired unlawful power to gouge consumers and make out like bandits. It was on that logic, in any event, that our vigilant antitrust authorities resolved to keep the two companies safely apart.
Both are now in bankruptcy.
It's not a new phenomenon: The competitive structures of the industries that are now keeping the bankruptcy courts so busy -- notably telecom, electric power and air transport -- have been shaped by regulatory commissions and antitrust courts who don't understand a thing about the subtle, complex economic forces that govern these capital-intensive network industries. Clumsy government policies intended to promote competition have played a pivotal role in creating boom-bust cycles.
Innovations and Subsidies
In the 1960s, long before the Internet made such capabilities commonplace, American Airlines pioneered the invention of a computerized reservations system (SABRE) that would eventually process millions of online transactions and allow for frequent fine-tuning of prices. United Airlines followed with its Apollo system. Both systems included flights from other carriers, but favored their own carriers' inventories. The innovations were revolutionary because of their impact on filling seats -- all important in a capital-intensive industry.
In 1984, however, regulators ordered American and United to stop giving their own flights any priority in their reservation systems, and to route inquiries in ways that took no account of the carrier's identity or its fee structures. This gave a big boost to other large companies that had neglected to invest early and effectively in comparable technology, and made it easier for small upstarts to enter the business and pick off profitable routes here and there. Bottom line: The industry's two largest players lost control of a key asset that they had built themselves, that perfectly complemented their extensive route systems, and that they would badly need, over the long term, to maintain stable profitability in a newly competitive environment.
Similar crises of regulation and inefficiency can be seen among other comparably structured industries to an even more aggravated degree. In the electric power industry, which has suffered enormous meltdowns in California, matching capacity at plants and capacity in wires with demand at the far end is shorted by a rusting system in which the flexibility to change prices is prescribed by a slow and cumbersome regulatory process.
To meet that challenge, utilities traditionally built and owned the plants that supplied most of the power to their wires, and signed long-term contracts with stable suppliers for the rest. Much of what has passed for "deregulation" of electric power in the last decade has consisted of orders to sever those links. Pacific Gas & Electric is in bankruptcy as a direct consequence of directives of that character; several other major utilities came perilously close to joining it before California threw out the whole sorry scheme. The state now blames others for having manipulated the market it tried to set up. But the whole point of owning assets and signing long-term contracts is to insulate yourself from price swings, whatever their cause.
Even seasoned investors and prudent corporate managers often misjudge the prospects for profit in industries that require huge amounts of capital to be invested years before it earns any return. Dumb money rushes in when capacity is tight and prices are high; prices then drop and asset values shrivel a few years later when there's a glut. But this natural cycle has been greatly amplified by regulatory policies that grease competitive entry at the front end of the cycle, and refuse to countenance any final exit at the back end.
Look at the adventures of telecom. The logic for breaking up the old Bell System in 1984 was to separate long-distance from local markets, to unleash competition on the long-distance side of the divide. Through the 1980s and into the '90s, however, federal regulators wouldn't let AT&T cut its long-distance prices, because the authorities feared -- correctly -- that AT&T could quickly wipe out at least one of its major competitors if it were free to do so. For good measure, regulators directed additional subsidies toward the upstarts by allowing them to pay much less than AT&T for their connections to local networks.
This scheme was maintained until burgeoning data markets attracted massive amounts of new investment. Then prices collapsed, and the entire long-distance industry is now on the brink of bankruptcy, with WorldCom over the falls.
Mergers have often been the rational response to looming capacity excesses in network industries, because larger companies can sell, retire and downsize by attrition much more smoothly than smaller ones. United Airlines and US Airways tried that approach in 2001, but (as we know) the authorities effectively concluded that the traveling public would be better served if the two companies found their own, independent ways into bankruptcy instead. WorldCom tried to merge with Sprint in 1999, but Justice wouldn't hear of it. WorldCom is now in bankruptcy and Sprint probably would be too, but for the revenues it earns from the local phone and wireless companies that it also owns.
Since competitors in network industries must interconnect, hand off traffic, and share customers and facilities, these industries spawn private antitrust suits as well, and they too have had far-reaching impacts on market structures. Antitrust litigators helped fund the young MCI when they extracted about $190 million in damages from AT&T and the Bell companies in 1985 -- the defendants had, once again, allegedly failed to grant MCI, their direct competitor, sufficiently ready access to their own networks. Covad is now suing Verizon and BellSouth, on exactly the same theory.
The bankruptcy laws, which might at least clean things up at the end of the day, now often make things worse. Chapter 11 "is like going to a car wash," one solvent but disheartened CEO of a small telephone company observed last July. Insolvent competitors "go in, they get their debt hosed off and they come back." Covad, which is now suing everyone else for damages, walked away from $1.4 billion in debt in a bankruptcy court in 2001; it now boasts of its "great-looking balance sheet -- perhaps the best in telecom."
What we now see in these industries is cut-throat competition among competitors that are collectively headed for insolvency, and who won't stop competing even when they do stop paying their debts. This isn't good for employees or creditors, whose long term interest lies in being able to market their specialized skills and products to a thriving industry. It's terrible for investors across the whole market because so many other sectors depend on the health of the infrastructure companies. And while consumers may benefit in the short run, the market will get its payback later, by postponing new investment in network expansion and innovation.
'Cuisinart' Policies
Regulators and antitrust courts must come to grips with the economic realities of network industries. Huge economies of scope and scale mean that competition will inevitably involve small numbers of very large players. 'Cuisinart' policies that chop and dice networks, services and corporations into little pieces don't promote competition, they undercut it. Most of the time, it's a mistake to force companies to share reservation systems, power transmission lines, copper loops and other core assets, on terms minutely prescribed by regulators. Such meddling promotes a short-term illusion of competition, but not the long-term reality.