The Economics of Pacific Bell v. linkLine Communications

The Supreme Court recently granted certiorari in Pacific Bell Telephone Co. v. linkLine Communications. The grant was controversial, with the Department of Justice urging the Court to hear the case and the Federal Trade Commission disagreeing. The case raises important questions concerning the antitrust economics of price squeezes and the incentives to invest in certain telecommunications networks.

linkLine accuses Pacific Bell (now AT&T) of setting its wholesale and retail rates for DSL service so close together that a competitor could not profitably buy wholesale DSL access and then resell the service to retail customers. Thus, linkLine accuses Pacific Bell of engaging in a classic price squeeze. The Supreme Court will decide whether a firm can be held liable for a price squeeze even though the firm is under no antitrust duty to deal.

At first blush, the economic implications of this case appear to be limited, at least in telecommunications, since the FCC does not require firms to grant wholesale access to new infrastructure. However, a ruling in favor of linkLine could have far-reaching implications for investment in any network subject to so-called “open access” requirements, such as those the FCC imposed in its most recent spectrum auction.

The open access rules stipulate that a network built using a particular part of the spectrum be open to any compatible device and service. The extent to which the network will actually be open will depend on the wholesale price for access, and no regulatory decisions have yet been made concerning that price.

Should the Supreme Court find for linkLine, then a company operating an open network could be subject to the argument that its wholesale and retail prices are too close together. By default, the first aspect of price regulation would therefore be a defined gap between the provider’s retail and wholesale prices. The result would be either a floor on the incumbent’s retail price or a ceiling on its wholesale price. Those limits make it difficult for the provider to compete at retail. Limiting the provider’s ability to compete will also limit potential returns from network investments. As a result, providers may reduce their investment, or perhaps choose not to build the network at all.

Scott J. Wallsten has worked on many telecommunications matters, including cable television, broadband and spectrum issues. He also has experience in antitrust matters in other industries.