72 with market entry. Network industries are particularly vulnerable to this type of market power because large infrastructure investments create scale advantages and are often to a large degree sunk.62 The preconditions which need to be fulfilled in order for a network element to be classified as a monopolistic bottleneck are very close to the definition of what is called an “essential facility” in U.S. antitrust laws. A facility is deemed essential when (Hausman and Sidak, 2000: 467): • it is controlled by a monopolist, • competitors are not able to practically or reasonably duplicate the facility, • the monopolist has denied competitors the use of the facility while • it is practically possible to make the facility available to competitors.63 In fact, the difference in these two concepts is not in their definition of what constitutes an essential facility or a monopolistic bottleneck but rather that an essential facility is a concept used in the context of general competition policy, which takes effect only ex-post and is applied on a case-by-case basis. A monopolistic bottleneck, on the other hand, is a concept based on economic theory and developed to identify ex-ante a class of cases which are in need of sector-specific regulation (Knieps 2006: 54). 4.4.2 The disaggregated regulatory approach The disaggregated regulatory approach (Knieps, 1997 and 2006) uses the theory of monopolistic bottlenecks to identify network-specific market power as a justification for sector-specific regulation. Since the theory of monopolistic bottlenecks uses a narrow definition of entry barriers, it is a suitable basis to limit regulatory intervention. According to the disaggregated regulatory approach, the task of regulation is to design a system for guaranteeing access to monopolistic bottlenecks (Knieps and Zenhäusern, 2008: 129).64 This regulatory framework recognizes the costs of regulation and calls for minimally invasive intervention into market processes. It argues that network industries consist of vertically and horizontally integrated markets of which many are (potentially) competitive and only some lend network-specific mar- 62 Von Weizsäcker points out that when economies of scale are present, very often the incumbent firm will own plant and equipment dedicated to the particular industry, such that the theoretical and empirical work on economies of scale as a barrier to entry may have misjudged the actual cause of the entry barrier (v. Weizsäcker, 1980: 401). 63 The federal courts first applied the essential facilities doctrine in 1983. In the case MCI Communications Corp. vs. American Telephone & Telegraph Co. the Seventh Circuit defined a four-part test by which the plaintiff needs to show “(1) control of the essential facility by a monopolist; (2) a competitor’s inability practically or reasonably to duplicate the essential facility; (3) the denial of the use of the facility to a competitor; and (4) the feasibility of providing the facility.” (Hausman and Sidak, 2000: 467). 64 The design of access regulation within the disaggregated regulatory framework will be introduced in more detail in Chapter 9. 73 ket power to a bottleneck owner. The disaggregated approach uses a layered model of network industries and examines the separable elements of the value chain in a disaggregated manner (Knieps, 2006: 53). It can thereby identify on the lowest specifiable level those market segments that are competitive and those market segments that are characterized by monopolistic bottlenecks. Access regulation is only to be applied to those network elements which conform to the definition of monopolistic bottlenecks.65 Figure 4.1: The localization of monopolistic bottlenecks Source: Based on Knieps, 2000: S96. Figure 4.1 illustrates the disaggregated regulatory framework. All network areas that do not show natural monopoly characteristics are characterized by active competition (quadrants 3 and 4). There is no need for sector-specific regulation in these 65 Laffont and Tirole (2000: 98) also distinguish between bottleneck segments and potentially competitive segments of network industries. They also argue for access regulation to bottlenecks in order to preserve competition in potentially competitive market segments. w/ sunk costs w/o sunk costs natural monopoly monopolistic bottleneck (1) contestable market (2) no natural monopoly active competition (3) active competition (4) Network area 74 network areas. Those network areas showing natural monopoly characteristics, but no substantial sunk investments, are considered contestable (quadrant 2). Only when natural monopoly characteristics are combined with substantial sunk costs (quadrant 1) should ex-ante regulation be considered. 4.5 Justifying interventions by general competition policy in network industries General competition law applies to all network industries, even if some market segments of these industries are subject to sector-specific regulation. If competition authorities find evidence for the abuse of market power by a market participant, they have the right to intervene into the market. Ex-post intervention by competition authorities is not based on a reference model comparable to the theory of monopolistic bottlenecks. If no monopolistic bottlenecks can be identified ex-ante, then only a case-by-case analysis can disclose those particular circumstances of a market that lend stable market power to a firm. As was argued for the case of sector-specific regulation, competition policy for network industries must also take into account that the nature of competition in network industries is complex. Competitive network markets will show market characteristics of monopolistically competitive markets. Product differentiation and price differentiation tactics make competition in network markets different from competition in markets of homogeneous goods. The traditional antitrust approach of measuring market shares in the relevant product market in order to prove market power is particularly inappropriate for network industries (Knieps, 2006: 70). The alternative methodological approach of using game theoretic models to prove the existence of stable market power in a particular market setting likewise is unsatisfactory in that such models typically simplify and therefore do not reflect the nature of competition in network industries correctly. Furthermore, game-theoretic models typically have multiple solutions (Knieps, 2006: 71). To prove stable market power that allows a dominant firm to make above competitive profits over an extended time period without inducing market entry, competition authorities must show, for a given market constellation, that entry barriers exist that prevent competitors from entering a market in which above competitive profits are being made. This requires a thorough examination of the competition dynamics in the market. 4.6 Conclusions Competition policy and sector-specific regulation have many limitations. Government interventions into market processes should therefore be applied restrictively. Sector-specific regulation generally infringes more on the freedoms of the regulated firm than antitrust policy. Furthermore, the likelihood of committing a Type-1 error is higher in sector-specific regulation when compared to general competition law.