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WorldCOM / MCI Merger Dont be a FOOL; The Law is Not DIY
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Network Effects in Telecommunications Mergers, MCI WorldCom Merger: Protecting the Future of the Internet, Address by Constance K Robinson, Director of Operations and Merger Enforcement, Antitrust Division, US Department of Justice, Before the Practicing Law Institute (Aug. 23, 1999):

"Overview of the MCI/WorldCom Transaction

"The MCI/WorldCom transaction, as it was originally structured, involved WorldCom's acquisition of MCI through a stock tender offer valued at $37 billion. WorldCom was one of the largest telecommunications companies in the United States, providing local and long distance telephone services and Internet access services domestically and internationally. With annual revenues of about $7 billion, WorldCom was the fourth largest facilities- based interexchange carrier in the United States. Additionally, through its ownership of UUNET, MFS Communications, ANS Communications, and CompuServe Network Services, it was one of the leading providers of Internet backbone transmission services. MCI, with annual revenues of $18.5 billion, was the second largest long distance telephone service provider, a leading provider of Internet transmission services (iMCI), and a recent entrant into the provision of local telephone services.

"Procedurally, the investigation itself was complicated because it involved reviews by a number of law enforcement entities--the DOJ, 16 states and the European Union--as well as a number of regulatory agencies--the Federal Communications Commission and state public utility commissions. While we and the EU conducted independent investigations, they were highly coordinated. With the parties' consent, the two agencies shared evidence with each other and held joint meetings with the parties. We also shared information about theories. The EU's investigation went into a Phase 2 proceeding, meaning that it issued a statement of objections and held a hearing on the merger. 

"Substantively, the transaction initially raised competitive concerns in four principal areas: long distance telephone services, local telephone service, international telecommunications networks, and Internet backbone services. We ultimately determined that the area of most significant competitive concern was the provision of Internet backbone services, or the provision of ubiquitous connectivity to the Internet. The merger would have combined two of the four leading nationwide or worldwide Internet backbones; MCI and WorldCom were the leading providers of wholesale Internet transmission services to ISPs and of dedicated access services to large businesses. Our investigation focused on what effect this combination, which would have created a dominant player in the provision of backbone services, would have had upon interconnection and access to the various networks that make up the Internet. We also examined whether the merger would give rise to market power through the powerful network effects that characterize the Internet.

Analysis of the MCI/WorldCom Merger

"While there have been changes in the Internet market since our investigation, at the time, we learned that the providers of Internet connectivity could be classified as a loose hierarchy broken down into roughly four tiers. . . . Given this complex and highly technical web of relationships, and the highly dynamic nature of a market characterized by rapid technological change, one thing was clear--defining a relevant product market was going to be a challenge. But after talking to competitors, customers, industry experts, and the parties, there seemed to be a national backbone market. Smaller regional backbone networks would not be adequate substitutes after the merger, because they would be dependent on MCI/WorldCom for Internet connectivity. Without MCI/WorldCom, the smaller networks would be unable to offer customers sufficient connectivity to all sources of content on the Internet. Also, as an industry participant we talked to during our investigation explained it, "ISP customers want to know a backbone is large enough to peer with the other big backbones before becoming a customer."

"The national backbone market was highly concentrated, with several significant competitors including UUNET, iMCI, and Sprint. The merger would have combined the facilities, personnel, and, perhaps most importantly, the customer bases of iMCI and UUNET, the two top backbone providers. The combined entity would have been by far the largest single nationwide backbone and Internet connectivity provider with an overall majority of customers (web sites, ISPs, and dedicated access corporate customers) connected to the Internet. Post-merger market shares for Internet connectivity ranged from 40-75%, depending on what measure of market share was used.

"Determining market shares was challenging because there was no commonly accepted method and there were legitimate questions about the accuracy of each method. In addition to public sources, we used a variety of other sources to evaluate market shares--interviews with industry players, internal documents from the parties and their competitors, and information we obtained through compulsory process. The two main public sources measured market share either according to shares of overall Internet industry revenues generated by ISPs that connected through various Internet providers, or according to the percentage of ISPs connected to a specific backbone versus the total number of ISPs connected to all of the backbones combined. According to the first measure of market share, 70% of the revenue generated by Internet providers would have purchased connectivity from MCI/WorldCom. According to the second method, used by Boardwatch Magazine, the combined MCI/WorldCom would hold an approximately 50% market share. Also, by this method, MCI/WorldCom and its next largest competitor would have together controlled a 75% market share, with the third largest competitor having only 4.4% of the market.

"Since there were questions about the accuracy of these measures, we examined market shares using other methods as well: Internet traffic originating, terminating, or otherwise traversing an Internet backbone's network (a measurement of size and significance of a backbone relative to other competitors); a revised revenue share that attempted to eliminate the double counting and irrelevant revenues; the number and type of Internet Points of Presence ("POPs") on a backbone's network; the number of circuits connecting customers to a backbone (which would correct for differences in customer size/significance); the number of "routes advertised" (or terminating IP addresses)--the density of a provider's network and web of customers, and finally the number, type, and significance of each network's customers. While none of these measures was perfect, each of them, while resulting in different absolute numbers, exhibited the same pattern. They all indicated that after the merger, MCI/WorldCom would be the dominant player in the market, and substantially larger than any other player.

"It was unlikely that entry would have eroded MCI/WorldCom's post-merger dominance because post-merger entry in the national backbone market would have been extremely difficult. Providing backbone services requires a large investment in telecommunication facilities. Even more significant is the need to obtain efficient interconnection with larger players. Without peering arrangements, a new entrant is substantially disadvantaged because it has to pay transit fees for interconnection, and many businesses are reluctant to become customers of a network that does not have a full set of peering arrangements. To secure such arrangements, however, the provider must have a large customer base. In this case, a new entrant would have to overcome the substantial advantage that a combined MCI/WorldCom would have had. Even John Sidgmore, who at the time was the Vice President of WorldCom and the CEO of UUNET, admitted that "[h]aving a big network is a huge barrier to entry for competitors."

Competitive Effects of the Merger

"Given the market structure and barriers to entry, what was the likely effect of the merger? In addition to a concern that the merger would facilitate tacit collusion, we were concerned about what effect it would have on the existing network. Prior to the MCI/WorldCom merger, no single backbone provider reached a disproportionate amount of destinations on the Internet relative to other major players. There was a rough equality, with each backbone provider depending on the other. Each backbone provider, therefore, had an incentive to support efficient interconnections because its failure to do so would have caused such a degradation of quality that it risked losing customers to the other networks. That incentive would change, however, if the two largest backbone providers were combined. But the MCI/WorldCom merger threatened to create a very large network with a huge size disparity. By representing a majority of the Internet customers, MCI/WorldCom would have been more valuable and been more important as a point of interconnection for other Internet providers, which would otherwise lose access to a great deal of the Internet. MCI/WorldCom would have far less need to depend on the other backbones than those backbones would have to depend on it. By giving MCI/WorldCom a disproportionately large customer base, the merger would have changed MCI/WorldCom's incentives from favoring compatibility toward favoring incompatibility. Recognizing this, there was widespread industry concern about the effects of the merger on peering arrangements and on interconnection prices.

"MCI/WorldCom's changed incentives would have increased the likelihood that it would attempt to tip the market by charging existing peers for interconnection or by degrading the quality of interconnections. MCI/WorldCom would have been able to do this, either through unilateral action, or through collusion with the only remaining player with a significant market share. The disproportionate dependence that other backbones would have had on MCI/WorldCom would have given it bargaining leverage to dictate the pricing and terms of interconnection. MCI/WorldCom could have begun charging peers for interconnection to its network, either all at once or on an individual peer-by-peer basis (by picking off the smallest rivals first), raising the costs of its rivals. MCI/WorldCom then could have chosen either to raise its own prices with that of its rivals, or to keep its price lower and let the market tip towards it, possibly leading to monopoly control of the Internet. Or MCI/WorldCom could have degraded the quality of its competitor's interconnections to its network. It could have done this either actively or passively, by not investing in the interconnections needed to keep up with the massive growth, and it could done this either to all competitors or on an individual basis. Interconnection points are constantly upgraded to keep up with the exponential growth of Internet traffic; any slowdown in the upgrading of these points would have serious effects on the quality of the connection. While this strategy would lower the quality of service for all networks, rivals' networks would suffer more degradation, allowing MCI/WorldCom either to increase its own prices, reflecting its better quality, or to gain market share. Again, with this strategy the market could have tipped to MCI/WorldCom, giving it monopoly control of the Internet. Under either scenario, WorldCom would have been able to purchase, through its acquisition of iMCI, market power and gain a monopoly, or at least a dominant, position in Internet backbone services.

"As I explained earlier, interconnection of multiple firms is not always the best or least costly way of achieving network efficiencies, but the history of interconnection in this industry suggests otherwise. Moreover, the parties failed to present any evidence suggesting that interconnection was inefficient or that it would be more efficient for MCI/WorldCom to be a monopoly provider. At this early, but critical stage where the development of cost-based pricing and other terms and conditions for interconnection are expected to be developed through bargaining among the industry's participants, allowing one player to achieve dominance through acquisition could have had an irreversible anticompetitive impact on this market. So we either had to try to block the merger or find another way to address our competitive concerns.

Remedy

"Since entry was not going to constrain a dominant MCI/WorldCom, any remedy had to create a viable competitor that would replace iMCI as a principal player in the national backbone market. The only way this was possible was through the divestiture of MCI's entire Internet business. As a condition of the EU's and our approval, MCI/WorldCom sold iMCI to Cable & Wireless for $1.75 billion. The divestiture was structured to include all assets, except for long-haul lines, and included the transfer of all of MCI's contracts with wholesale and retail customers for the provision of Internet backbone services, the transfer of all necessary employees to support the iMCI business being transferred, and all other necessary support arrangements to fulfill existing contractual obligations of the iMCI business. MCI/WorldCom was to refrain from soliciting or contracting to provide dedicated Internet access services for a specified period. MCI/WorldCom was also required to assign to Cable & Wireless iMCI's peering agreement with WorldCom and agree not to terminate that agreement for a period of five years. These conditions were imposed to ensure that the new competitor would be a significant player with the ability to compete effectively with MCI/WorldCom. It is important to note that the relief we obtained does not preclude MCI/WorldCom from eventually reaching a monopoly position. It is possible that in the future the market may tip, having MCI/WorldCom as the dominant player, but if that does happen, it will be because the company out-competed the other networks, not because it bought customers.

NOTE:  The one "asset" that did not go from MCI to Cable & Wireless was Vint Cerf, who joined the new MCI / WCOM company.

Conclusion

This merger was important because, without the divestiture, it could have had a significant and negative effect on the Internet, an emerging industry that thus far has functioned successfully without regulation. Allowing one player to achieve dominance through acquisition could have had an irreversible impact on this market and could have stifled competition at a critical stage in the development of the industry.

Petition by WorldCom and MCI for FCC approval of Proposed merger. FCC Public Notice DA 97-2494

MCI Voluntarily Divests of MCI Backbone

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