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An analysis of telephone company entry into unregulated markets: the electronic security case.

I. Introduction

Since 1984 we have had a district court judge making public policy with regard to the entry of the Regional Bell Operating Companies (RBOCs) into information-based service industries. For the most part, the debate about appropriate public policy, and who should have responsibility for its formulation, has been quite general. Opponents of entry have raised concerns about possible cross-subsidization and the concomitant opportunity for abuse of monopoly power. Proponents of RBOC entry have cited the myriad possibilities for new information services like those afforded by the French telecommunications system.

The breakup of AT&T traded a national monopoly for a number of regional monopolies, the RBOCs. The competitive electronic security industry generates and processes data that are carried by the RBOCs. The technology used by the RBOCs and the electronic security industry is quite similar. In contemplating entry into electronic security by the RBOCs one must evaluate the likely (anti-) competitive impact.

In this article we consider a specific case: RBOC entry into the electronic security industry. Traditionally, the evaluation would include an assessment of whether such entry would afford an opportunity for monopolization by the new entrant. The analysis would hinge on product and geographic market definitions and on the behavior exhibited by incumbent firms. Embedded in such analyses are a number of implicit assumptions. Namely, there are assumed to be no public good aspects to the goods markets, there are no externalities, and there are no complementarities in consumption and production between the market in question and other markets. Under these assumptions, new entrants will not reduce consumer welfare.

The electronic security industry provides a novel benchmark for RBOC entry into information-based industries because many of the usual assumptions are not valid. There are two sources of externalities in the consumption of electronic security. First, neighborhoods in which a high proportion of homes have alarms have lower burglary rates. Second, a false alarm reduces the police services available for consumption by other households in the community.

If the electronic security industry is already competitive and affords no opportunities for monopolization, then there should be no reason to bar RBOC entry. However, there may be other issues, the assumptions outlined above, connected with RBOC entry that may reduce consumer welfare. The purpose of the present article is to consider the usual monopolization arguments as well as the ancillary issues that are common to other information-based industries from which the RBOCs have been denied entry. In particular, we examine the gains to the RBOCs from entry, the possibility for anticompetitive behavior, and the appropriate public policy response to entry.(1)

Section II uses the structure-conduct-performance paradigm to analyze the competitive nature of the electronic security industry. In so doing, the opportunities for monopolization by the RBOCs are reviewed. The section also considers the complementarity, externality and wealth transfer issues.

Section III analyzes current policy regarding RBOC entry into the information services. The district court has become a de facto regulator. The logic of this position, vis-a-vis electronic security is analyzed.

Section IV looks at the nexus between the RBOCs and the alarm industry. The discussion in this section considers whether Judge Greene's stance has any relevance to electronic security. Presumably Greene has barred entry on the ground that the RBOCs could monopolize the industry. Others might argue that entry should be barred on the ground of other welfare effects. Our analysis will suggest that for any such problems there are more appropriate remedies than barring entry. Finally, if anticompetitive activities are unlikely to be profitable, then RBOC entry ought to be allowed.

II. The electronic security industry

The alarm industry is composed of four parts: manufacturers of intrusion and fire detection sensors and control panels, distributors of this equipment, installers of systems, and companies that monitor the systems and respond to emergencies.(2) Only the largest firms are integrated from manufacturing through to monitoring and response. This industry first came to the attention of economists in U.S. v. Grinnell Corporation in which it was ruled that the defendant had attempted to monopolize a segment of the alarm market.(3)

A. Manufacturing

Structurally, substantial competition exists in manufacturing. Ninety-two establishments were engaged principally in the manufacture of alarm systems in 1987.(4) Recently AT&T has joined the ranks of manufacturers of detection equipment and markets that equipment through licensed installer/dealers. Michigan Bell designed a control panel for the monitoring of its remote switching stations and has since licensed the design for manufacture.(5) Indicative of the small size of the facilities in the alarm equipment manufacturing industry (SIC 36991) is the fact that, in 1987, production workers per establishment numbered only seventy-two. In telephone and telegraph apparatus, in contrast, the figure was 125. Concentration, the share of the market held by the largest firms, in manufacturing is not high and market shares are fairly evenly distributed. The largest manufacturer has about 10% to 15% of the market, and the top ten have no more than 80%. There are many small, specialized firms that serve to constrain the leading manufacturers. Moreover, concentration declined between 1982 and 1990, suggesting that smaller firms are no less efficient than larger ones;(6) the efficient level of production is quite small and, as shown below, there are no economies of scope between manufacturing and the other industry components.

Thus, economies of scale do not represent a significant entry barrier. Other conceivable barriers to entry include patents, ownership of key inputs, cheaper (more ample) capital, and advertising-induced product differentiation. As sensor equipment uses essentially "off-the-shelf" infrared, microwave, and electronics technology, patents do not play an important role in preventing market entry by new firms. In fact, product development expense is rather modest. New products take an average of 9 months for development and require an average investment of $150,000.(7)

There are no unique inputs that can be controlled by a single firm. The small scale of incumbent firms limits the extent to which capital requirements could serve as a barrier to entry. The fact that there are very few publicly traded alarm manufacturing companies suggests that the capital needs of the industry are modest and require little external funding. Finally, advertising in all parts of the electronic security equipment manufacturing market is minimal and is geared mostly to knowledgeable industry insiders.

In addition, knowledgeable buyers like major wholesalers could use their substantial purchasing power to insure competitive behavior through whipsawing the manufacturers. Approximately 40% of alarm equipment is sold through wholesalers.(8) Evidence of the potential for this disciplinary device is offered by the fact that the average installer bought alarm systems equipment from four suppliers in 1986. Moreover, electronics firms not in the industry could easily enter should prices exceed the competitive level. Finally, vertically integrated manufacturers that install only their own equipment and do not sell equipment to other downstream firms could expand into sales to wholesalers should prices at that level of the industry become attractive.

Indicative of competitive pricing is the fact that in 1987 price exceeded variable cost by only 60%, implying a price elasticity(9) (assuming profit maximizing behavior) of 2.7. Such a value for the industry price elasticity is consistent with competitive pricing.

B. Installation

Installation of alarm systems is also a highly competitive segment of the market. In 1990 it was estimated that there were 10,000 installers nationwide.(10) The top twenty-five were estimated to account for 40% to 50% of the industry's total sales. In a local market, the relevant locus of competition, there are also many firms. For example, Lower Bucks County, Pennsylvania had at least eighty-eight firms advertising to install burglar alarms in 1988.(11) Thus a small area like Lower Bucks has a substantial number of firms. Lower Merion Township, with about 19,000 dwelling units, reported that 332 installers were doing business within its borders in 1989. This was an increase of sixty-eight firms over the previous year.(12) In addition, electricians, locksmiths and others install alarm systems, and even self-installation is feasible.(13) Not only are there many firms but entry into the market is easy; entry and exit barriers can both be described as negligible. Since alarm installation involves low voltage electrical work there are no significant institutional barriers.(14) The requisite knowledge and skills are also easily acquired. Many start-up firms have their origins in the owner's previous employment with an incumbent. Also, the industry operates a training institute and conducts training seminars at numerous state and national trade association meetings. About the only possible cost of entry might be some modest advertising. Easy entry and exit has resulted in an industry in which 12% of the firms are less than 2 years old and 32% are less than 5 years old.(15)

Easy entry and a large number of competitors means that no more than normal economic profits should be earned in the long run. Moreover, easy entry means that if profits exceed the normal level, new firms would quickly enter to eliminate the profits. Indicative of the low level of profitability is the statement:

A lot of dealers believe that they have to make a substantial cash

investment in a system, so they constantly lose money up front on new

business with the intention of making it up down the road on the

monthly service fee.(16) The notion of recurring revenues is the operative phrase in the industry, but the industry authority quoted above added that the low initial price strategy was often unsuccessful. The strategy has proven unsuccessful because a large dealer can expect his subscriber list to turn over every 5 or 6 years, thus limiting the ability to recapture the loss on installation.(17)

Not only has concentration been low and entry easy but other factors like modest product differentiation and the incentive to charge low hardware prices would make coordination difficult even if concentration were to increase substantially.

C. Monitoring

The other retail level of the industry also had a considerable number of firms in the relevant local markets; for example, in 1987 Philadelphia had seventeen establishments monitoring alarm systems and Montgomery County, Pennsylvania had twelve.(18) The average annual sales in Philadelphia were $1,359,824 and in Montgomery County they were $1,719,000, suggesting the modest size of the operations. In 1987, for the U.S. as a whole, there were 2451 monitoring establishments with an average revenue of $904,781. Although vendors use geographic proximity to the client as a sales ploy, the monitoring market is actually national by virtue of modern telecommunications and computer software.

Labor costs comprised a large portion of the expenses of these firms; in Montgomery County labor costs were equal to about 45% of the revenue of the firms, and in Philadelphia they amounted to 38% of the revenues. For the nation labor costs comprised 35% of firm revenues. Moreover, entry barriers are quite low in monitoring.(19) Indeed, only about 1000 subscribers are required to cover all costs. Adding to the competitive pressures on local monitoring firms is the existence of national and superregional firms. These firms can enter a new market through acquisition of a small installer/dealer. Because of their size they are able to economize on the use of labor for the production of a somewhat reduced level of service to the consumer.

Adding to the competitive pressures exerted by the national and superregional firms is the potential entry of the RBOCs. A number of them have been offering a derived channel service that surveys the phone subscriber's circuit for integrity. The monitoring central stations are already value-added resellers of this service element. USWest, NYNEX and Bell Atlantic have not found much of a market for this service since it is typically priced as an additional 50% of current residential monitoring fees. More importantly, USWest has proposed a rule change to the FCC that would allow it to enter monitoring per se.(20)

Essentially, then, the entire electronic security industry is highly competitive.(21) Competition exists among manufacturers, distributors and installers, and among firms monitoring the alarm systems. Vertically integrated firms like ADT insure that prices at every level are competitive and reflect any additional savings from vertical integration. These companies produce and install equipment and monitor the establishments where their equipment is in place. Should any level become more profitable, the vertically integrated firm could then serve other firms, as well as its own downstream unit.

Furthermore, demand for alarm systems has not exhibited exceptionally rapid growth. One could argue that even if competition exists, short-run profit may be earned because of rapid growth. But growth has not been rapid: for example, between 1982 and 1987 shipments of alarm systems grew by about 52%, an annual rate of 8.7%, while shipments of telephone equipment grew by about 65%, an annual rate of 10.5%.

Given that the prospects for exceptional profit in the alarm industry are not evident, two questions remain: Why would the RBOCs want to enter? and what ought the public policy position be on their entry? Clearly, the complementarity between telecommunications and electronic security has been recognized and entry has been at least contemplated. For example, one RBOC has stated in support of allowing RBOC entry into information services:

The same technical elements of a sophisticated telephone network that

make "911" emergency services possible could be used to bring a host

of other timesaving services to all Americans. Consider the benefit

to our citizens of universally available and reasonably priced alarm

services, home energy management services, voicemail for parents to

use in communicating with "latchkey" children....(22) At a certain level, the question of entry is already moot. The RBOCs all have unmanned, remote switching stations. In most cases the local operating companies have designed and installed their own systems for monitoring the remote station for intrusion, fire, and other environmental changes. The RBOCs have also provided basic service elements that are similar in spirit to the business of an alarm company or that are purchased by an alarm company for resale to the public. An example of the former is the E911 service that allows the transmission of detailed emergency information to the local police department or other agency. An example of the latter is the derived channel service that permits continuous line monitoring to thwart burglars who would cut the phone line to defeat the burglar alarm. Also supporting the possibility of RBOC entry is the entry of non-RBOC telephone companies like Continental in the Wilkes-Barre-Scranton, Pennsylvania market and Pacific Telecom in Vancouver, Washington.

It is apparent that there are no important economies of scale in any of these product groups. Since there are firms operating side-by-side that are involved in one, some, or all industry segments, it is reasonable to conclude that there are no economies of scope available to alarm industry firms. The question that remains is whether a structurally separate RBOC subsidiary will be able to find and exploit economies of scope between the four segments of the alarm industry and its core lines of business.

There is the possiblity that there are economies of scope between the core business of an RBOC and alarm services since an essential part of the latter business is alarm transmission. To the extent that such economies of scope exist they are likely to arise because of shared facilities at the RBOC's switching station or local exchange. These economies could be overcome through actual or virtual co-location of independent alarm services companies at the RBOC facility.

While there do not appear to be economies of scope in the four traditional lines of the alarm business, this does not preclude other possibilities. One such possibility is economies of scope in product marketing. The RBOCs have gained considerable experience in recent years in direct marketing of telecommunications services and products. Their mailing lists alone are an extremely valuable marketing tool,(23) and so is the name recognition associated with the supply of basic phone service. Most alarm companies acknowledge that reputation is an important component in their marketing effort and that reputation is earned only after years of faithful customer service. The RBOCs already enjoy that reputation.

The alarm industry views the financial clout and marketing power of the RBOCs with great trepidation.(24) Their concern is so great that they have established the Alarm Industry Communications Committee and associated Political Action Committee for the purpose of lobbying the U.S. House and Senate. The prime recipient of their support has been H.R. 5096 introduced by Rep. Jack Brooks (D-Texas). The bill would prohibit RBOC entry into the alarm industry for 3-7 years, and then only subject to Justice Department review.(25)

III. Public policy issues and RBOC entry into information services

Under the 1982 decree that provided for the breakup of the Bell System, the seven regional Bell operating companies were prohibited from providing information services. Those services include:

... the offering of a capability for generating, acquiring, storing,

transforming, processing, retrieving, utilizing or making available

information which may be conveyed via telecommunications.(26) In March 1988, the district court modified the decree to permit the transmission of information services generated by others but retained the prohibition on the generation or production of information by the RBOCs in their regulated areas.(27) The RBOCs were allowed to provide voice storage and retrieval services. The district court retained the general prohibition against generation of information that presumably would include electronic monitoring or alarm services because it concluded both that the RBOCs still enjoyed bottleneck control over local exchange services and "... information services are especially vulnerable to even slight manipulation and discrimination by the entity providing transmission."(28)

The district court found that in 1987 only one-tenth of 1% of interexchange traffic reaches an interexchange carrier without use of the local RBOC,(29) reflecting no reduction in monopoly power of the RBOCs. Moreover, the court was concerned about the possible use of cross-subsidy to disadvantage competitors in information services and was not convinced that RBOC entry would provide positive benefits to consumers.(30) The standard used by the court prevented removal of the prohibition unless "there is no reasonable possibility that it could use its monopoly power to impede competition in the market it seeks to enter."(31)

The district court believed that allowing only transmission of information like alarm signals by an RBOC would not provide the RBOCs with an incentive to discriminate against providers of electronic monitoring. In other words, allowing only transmission would eliminate any incentive to discriminate since the RBOC would not be trying to serve the same market as that served by its own customers and would thereby comply with the above judicially mandated standard. As mentioned, the district court did allow voice messaging and retrieval services. It noted that the presence of answering machines, answering services, and other alternatives would prevent monopoly control of this market. Even if an RBOC were able to eliminate answering services and bureaus, consumers would retain the ability to use answering machines. This same alternative would restrict the RBOCs' efforts to raise price substantially. The possibility of substitution by the end user would presumably reduce the incentive to engage in anticompetitive behavior.

The district court recognized the possibility of recoupment or the lack thereof as an important element in assessing whether entry will possibly harm competition. In addition, the district court removed restrictions on nontelecommunications activities because cross-subsidization would be more easily detected in such cases.(32) The 1990 settlement involving NYNEX and one of its subsidiaries is indicative of ongoing attempts to shift costs to the regulated entity and the ease with which such behavior cna be detected.(33)

An appeals court in reviewing the district court's decision on information services made several important findings that greatly increased the likelihood that the RBOCs could enter information services in general and electronic monitoring in particular. It noted the district court's concern that the RBOC entry would harm small and innovative firms:

New entry or increased competition in any market typically hurts and

sometimes even destroys existing competitors. A court's solicitude for

those firms--ostensibly in an effort to foster competition--may well

come at the expense of competition.(34) Most significantly the court stated that:

... unless the entering BOC will have the ability to raise prices or

restrict output in the market it seeks to enter, there can be no substan-

tial possibility that it could use its monopoly power to impede compe-

tition.(35) Given the highly competitive (and easy to enter) electronic monitoring industry, it seems quite unlikely that price could be raised above the competitive level. Accordingly, it would seem as if the RBOCs cannot be barred from entering competitive industries. In fact the appeals court stated:

... if the BOC wants to enter a competitive market, that is a powerful

reason to grant the section VIII (c) petition since there is less of a dan-

ger that the BOC will be able to seize and wield market power.(36) If the market to be entered were concentrated and not acting competitively, the court stated that entry might be justified even though the RBOC could more easily acquire market power.

The appeals court noted that the impact on regulated rate payers is not the focus of inquiry or even relevant in the normal case. Regulatory agencies are supposed to oversee such matters. The district court's function is to remove restrictions on the RBOCs if they cannot restrict output or raise price in the markets to be entered.

The appeals court decision also mandated that the district court rely heavily on the Justice Department's opinion that RBOC entry into the information services industry would increase competition. Accordingly, despite strong reservations, Judge Greene removed the restrictions on RBOC entry.(37) He noted that the RBOCs are in essentially the same position as AT&T prior to its breakup, namely the RBOCs control access to an essential facility, the lines to the final user of telephone services over which 99% of the calls still travel.(38) The district court stated that the RBOCs could conceivably raise the costs of information service providers, like alarm companies, and thereby enhance their own competitive positions and profits.(39) This danger does not seem likely and will be discussed below. The court was also unconvinced that the riskiness of a discriminatory policy would deter the RBOCs. It noted both that regulation did not prevent anticompetitive activities toward competitors before divestiture and that regulation was even less likely to be effective now, given the greater variety of products and services that the telephone companies offer. Open network architecture, the breakdown of costs into specific functions, was also not viewed by the court as a panacea since it had not yet been implemented:(40)

As for ONA rules that have been in place over the last several years,

they have already provided some indication of their lack of effective-

ness: they have not prevented the Regional Companies from discrimi-

nating against their competitors in the few markets in which such

discrimination was at all feasible.(41) The court reported that affidavits concerning the voice message market claimed that the RBOCs designed features to increase incompatibility with competitors' standard equipment, priced features to increase rivals' costs, provided certain features only to their affiliates, and delayed offering features desired by competitors until the particular RBOC was prepared to offer the features.(42) The RBOCs also enjoy the advantage that the independent information service competitors, like alarm companies, must provide the RBOC with technical and marketing data that can then be used by the RBOC in its planning or marketing decisions. Finally, the court was unconvinced that cross-subsidization could not be profitably employed to hamper independent information service providers. The court obviously believed that the regulated monopoly provided the means to subsidize competitive activities. In any case, despite serious reservations, Judge Greene permitted the RBOCs to offer information services, and subsequent appeals court action now has affirmed the decision.

In evaluating the appeals and district court decisions, it is important to examine the issue of cross-subsidization. Judge Greene was concerned about its possible use by the RBOCs. The two generally acknowledged motives for cross-subsidization by a regulated firm involve an increase in the rate base where the allowed rate of return exceeds the cost of capital and the shifting of profits to an unregulated (or less highly regulated) part of the firm's operations.

Under the regime of regulated pricing where costs of the competitive and unregulated activity could be recouped through higher prices for telephone company services, such a cross-subsidization strategy might well have been reasonable. It would have yielded a greater capital requirement and if the regulated rate of return exceeded the cost of capital, the firm might have made profits from the losing activity. The current trend toward use of incentive regulation and price caps provides the RBOCs with much greater incentive to cut costs, thereby adding to profits, rather than expanding the rate base to increase profits. Price caps simply set price at some level (based on expected productivity growth and the rate of inflation) and the utility reaps all of the gains from cutting cost. Incentive regulation also prevents price from being increased in the regulated activity, which greatly lessens the gains from expanding the rate base.

The transfer of RBOC profits to an unregulated alarm subsidiary is also unlikely. For this strategy to be profitable, the firm must have the ability to raise price in the regulated monopoly market. But, as noted, incentive regulation both prevents such an increase and raises the gains from cost-cutting in the regulated market. Successful profit transfer also requires raising the costs of incumbent alarm (especially local usage) probably comprise a small part of the total expenses of an alarm company. Hence, an RBOC would have a difficult time substantially raising the costs of an incumbent's alarm system network. Incidentally, telephone charges probably constitute a much greater portion of total costs for message service companies, making discrimination much more feasible for that product.

Given the experience with the predivestiture AT&T and the voice message market cited by Judge Greene, some, perhaps small, probability exists that the RBOCs might try to discriminate against the alarm competitors. The cost to society in terms of legal and administrative resources might outweigh the gains resulting from increased competition in the alarm or other inforamtion service industries. Indeed, a major justification for a structural remedy like the AT&T breakup is precisely to save administrative and judicial resources through removing the incentive for anticompetitive activity. Given an already competitive industry, the possible static gains to consumers from RBOC entry are probably small. Accordingly, even if there were some improved performance in the alarm industry (which is questionable), barring any consideration of dynamic efficiency, the overall cost to society might still be greater than the benefits. However, entry ought not be barred unless there exists a clear danger of anticompetitive activity, a situation that is absent in the case of electronic security.

There is also the equally persuasive argument that precluding RBOC entry at the present time will result in judicial and administrative costs. As technology makes industry and product definitions increasingly malleable, more resources will have to be expended in the pursuit of defining the alarm industry and those who would enter it. Even on the grounds of administrative cost, allowing entry may be desirable.

The remaining motive for RBOC cross-subsidization is simply the familiar one of driving out alarm company competitors and then later recouping foregone profits. However, as the appeals court recognized, the absence of entry barriers makes such a strategy unlikely; prices could not be raised enough at a later time to make the strategy profitable.

The decision then to allow entry is reasonable. Indeed, as the U.S. Supreme Court noted in Matsushita Electric Industrial Co. v. Zenith Radio Corp.: "... the absence of any plausible motive to engage in the conduct charged is highly relevant to whether a 'genuine issue for trial' exists within the meaning of Rule 56(e)."(43) Similar reasoning is applicable with respect to the entry of RBOCs into the alarm industry.

IV. The nexus between the RBOCs and the alarm companies

In the case of the alarm industry, the possibility of RBOC entry would probably provide few obvious benefits to society from increased competition. The industry is already competitive. Dynamic gains are, of course, possible. In any case, the antitrust policy question is whether entry would substantially lessen competition. Although it is unlikely, as we have already suggested, suppose that RBOC entry could lessen competition in the industry and the RBOCs are mistakenly allowed to enter. It is our contention that although entry might be permitted, the RBOCs would not take advantage of the opportunity in a significant fashion.

The RBOCs would seem to have far better alternative investment opportunities, including overseas communications, new phone networks in the countries emerging from behind the Iron Curtain, and domestic cellular, among others. Especially attractive is entry into the provision of television service in competition with cable TV companies.(44) Associated with these more lucrative endeavors is the financing of a fiber-optic network. It seems that the RBOCs face an uphill struggle in getting rate hikes approved prospectively in order to build the network.(45) Equally problematic for the RBOCs is the possibility that they might find cable TV companies encroaching on lines of business that have been the traditional purview of the Bell operating companies.(46) Finally, these more attractive opportunities make it both irrelevant and costly to engage in anticompetitive activity in the alarm industry.

In the lessening of competition scenario, the question still remains as to why the RBOCs might want to enter the electronic security industry. It is conceivable, but unlikely, that the RBOCs observe a market or segment that is not currently being exploited. Entry into the mass market, low-price end would force the RBOCs to compete with such strong rivals as ADT, Brinks, Westinghouse, and possibly even Sears. The high price, custom market would involve highly labor-intensive activities and heavy marketing, neither of which is desirable for the RBOCs. The RBOCs have worked very hard to reduce their workforce. Compared to 1950 the local operating companies now process six times as many calls with 80% fewer employees.(47) They now have fewer than five employees per thousand lines and are continuing to reduce the number. The alarm industry on the other hand, employs about 1.2 persons per thousand subscribers. The difference in labor intensity is in "conversations" per day. An alarm company must respond to an average of 1.7 activations, "conversations," per subscriber per year.(48) A typical phone company has an average of 1523 calls per employee per day.(49) The phone company provides a mechanism to carry and store messages. Responding to all these messages, which is the bailiwick of the alarm companies, is inconceivable for the phone companies.(50) However, the telephone companies might well enter just the marketing and installation of alarm equipment. Here again there seems to be little incentive to enter.

There are also allocational issues that will result from RBOC entry into alarm services. To be a worthwhile venture the RBOCs would need their alarm subsidiary to grow to a $100 million business within 5 years.(51) An RBOC would have to become one of the ten largest alarm companies in this period. If the RBOC confines this effort to its own market area and concentrates on local markets, as is typical in the industry, then we can expect to see enormous market penetration in some localities. This would be roughly equivalent to increasing the number of installed systems in every municipality in, say, Bell Atlantic's geographic market by about 50%. If alarm services were consumed by the purchaser as a final product there would be no problem. However, the alarm system is ultimately consumed in conjunction with emergency response, usually provided by the local police department. This results in a transfer of wealth from households who do not own alarms to those who do.

The transfer occurs in part because not all alarm activations are bona fide. Municipal police departments estimate that more than 98% of alarm activations are false and that they expend as much as 15% of their resources and 25% of their person-hours in responding to false alarms.(52) Since the user fee imposed on the alarm owner in the event of a false activation does not correspond to the resources expended, nonowners are subsidizing consumption of police services by alarm owners. It is unlikely that with current staffing police departments could be responsibe to the demands placed on them by new alarm customers added by RBOC entry into the industry. This is, however, an argument against an inappropriately low user fee for false alarms rather than an argument for barring RBOC entry.

Indeed, some communities have already begun to deal with the pricing issue. The burden of false alarms has approached the point where some municipal police departments do not respond to chronic offenders.(53) Other communities have taken the step of requiring that all calls for alarm response be amde on a 900 number.(54) This raises user fees in an innocuous fashion and solves some of the collection problem. A final group of communities have taken the approach of not responding to whole categories of alarm users. Multnomah County, Oregon came close to initiating such a policy in 1991. Suffolk County, New York adopted a policy in 1992 of not responding to business alarms.(55)

Second, the impact of responding to false alarm activations serves to reallocate police presence toward those neighborhoods with many alarms; the remaining neighborhoods are able to consume fewer police services. The reduction in police services for nonalarm households represents a reallocation of wealth that may not have been anticipated at the time of home purchase. Correct pricing of police response would reverse this reallocation.

Third, it has been observed that alarm equipped households, and neighborhoods with many such households, experience lower burglary rates, ceteris paribus. The burglars shift their focus to households and neighborhoods that involve a lower likelihood of apprehension. To the extent that alarm owners can shift the burden of the incidence of burglary to other households there is an additional transfer of wealth away from households who don't own alarms. Again, after some thought, this is an issue that is not relevant to antitrust policy.

The market solution to the growing number of alarm systems and false alarms may be private guard response. In urban areas like New York and Los Angeles some alarm companies provide private response for their clients. To some this is at best a form of vigilantism that could in certain scenarios lead to virtual private police forces operated by the wealthy.

All of these concerns suggest that an externality exists in the provision of home security services. There are externalities in both the production and consumption of alarm monitoring and response. If user fees for response to false alarms are inappropriately low then there will not be an efficient allocation of resources. Even absent additional entry, society might want to insure correct pricing for false alarms.

In any case, in the antitrust decision concerning RBOC entry into the full panoply of information services, the computation of costs and benefits cna still be confined to the traditional elements. There are, for example, claims that the modified final judgment is at least in part to blame for the U.S. lagging behind other countries like France in the full range of telecommunications services, an argument with which the district court disagrees.(56) It is also unlikely that RBOC entry into the alarm industry will substantially lessen competition in that industry. In fact, the industry may experience new growth in research and development resulting from the entry of the seven RBOCs, which are large and technologically sophisticated firms. However, given the difficulties regulated firms frequently encounter when forced to compete, RBOC entry may well prove to be at most modestly successful.

In summary, although the RBOCs now can enter information services, there seems to be little incentive to enter the alarm industry nor a significant net gain to society from their entry. Nevertheless, it would be unwise public policy to exclude firms where there is no substantial probability that competition will be impaired and where dynamic efficiency may be enhanced. It is questionable whether the RBOCs can obtain the necessary penetration to be profitable or foster technological growth, although barring their entry would preclude achieving dynamic efficiency. And the latter is probably more important than static efficiency. The RBOCs enjoy far more profitable alternatives like cable TV.(57) Moreover, an important traditional component of the alarm industry involves monitoring, which is a labor intensive activity, something that the RBOCs seem not to want.

In spite of the cost to society in reducing at least the predictable claims of cross-subsidy, a reasonable position would be to permit RBOC entry into competitive industries like electronic security. Such arguments for excluding RBOCs as exacerbating an externalities problem were shown to be more appropriately handled by other policies. At the same time, it may be good policy to foster RBOC development of new information services products by looking at lines of business rather than the agglomeration of information services. For example, Pacific Telesis is launching a motor vehicle tracking and recovery business in a number of major metropolitan areas. This is a desirable information services market that has not heretofore been served.(58) It also illustrates the unforeseen and unanticipated benefits of allowing additional entry by RBOCs. Our conclusion, then, is that the barring of RBOC entry is both unnecessary and irrelevant.

(1)The topic is particularly timely since the Bryant (House)/DeConcini (Senate) bill would explicitly exclude the RBOCs from security alarm monitoring. Alarm Monitoring Industry in the U.S. Fears RBOCs, CANADIAN SECURITY, June 1993, at 13.

(2)In some areas the response is by the monitoring firm, while in others the emergency signal is passed to the local police department for response. Of increasing importance is the firm that offers contract response to monitoring firms or directly to alarm system owners, as in the Los Angeles area. See Jerry A. Usher, Privatization in Criminal Justice: One Perspective in Southern California, in PRIVATIZING THE UNITED STATES JUSTICE SYSTEM 138-52 (Gary Bowman et al. eds., 1992).

(3)U.S. v. Grinnell Corporation, 236 F. Supp. 244 (D.R.I. 1964), aff'd, 384 U.S. 563 (1966).

(4)Unless otherwise noted, aggregate industry statistics are from, U.S. DEPARTMENT OF COMMERCE, BUREAU OF THE CENSUS, 1987 CENSUS OF MANUFACTURES at 36D-1 (1990).

(5)Bob Fuhrman, An Alarming Solution, TELEPHONY, July 3, 1989, at 22.

(6)This argument is based on the survivor principle first articulated by George Stigler, The Economies of Scale, 1 J. L. & ECON. 54, 154 (1958).

(7)Products Take Average of Nine Months, $150,000 to Develop, SECURITY SALES, Mar. 1992, at 54.

(8)This statistic is from SRI RESEARCH CENTER, INC., 1987 NATIONAL SURVEY OF DEALERS AND INSTALLERS OF SECURITY AND FIRE PROTECTION EQUIPMENT (1987), for the Security Equipment Industry Association and STAT Resources, Inc.; NATIONAL SURVEY OF DEALERS AND INSTALLERS OF SECURITY AND FIRE PROTECTION EQUIPMENT (1983), for the Security Equipment Industry Association.

(9)Price elasticity is the percentage change in quantity sold when price is changed by 1%.

(10)The reported number of installers varies from 8000 to 10,000 depending on the source used. See note 8, supra, for two examples.

(11)Lower Bucks borders on Philadelphia. It encompasses ten townships. It had a population of approximately 310,000 in 1984. We obtained our count for the number of firms from the Yellow Pages. Thus, since firms from other areas could operate there, 88 is a lower bound for the number of firms that can do business in Bucks County.

(12)The statistics were compiled from police department data and are reported in SIMON HAKIM & ANDREW BUCK, RESIDENTIAL SECURITY: AN ALARM EFFECTIVENESS STUDY (1991), for the Alarm Industry Research and Education Foundation and the Pennsylvaia Burglar and Fire Alarm Association.

(13)Expander Technologies in Canada and Quorum in the U.S. are now selling do-it-yourself systems via network marketing. There is virtually no investment capital required to begin as a sales representative. See, for example, Patricia M. Padilla, Networking Can Benefit Everyone with Quality Sales Leads, SECURITY SALES, July 1992, at 50-61.

(14)Many localities require that installers have a low voltage electricians permit. There usually is no licensing test and the fees are invariably less than $100. Although many local security company trade associations are lobbying for statewide licensing to replace licensing at the municipal level, such legislation would not pose a significant barrier.

(15)Dealer Survey, SECURITY SALES, Mar. 1992, at 10.

(16)Lisa Spooner, Pricing for Profit Now, Not Later, SECURITY DISTRIBUTING & MARKETING, July 1990, at 67. Curiously, the majority opinion in Grinnell was that such low pricing in a market segment was evidence of monopoly rather than real or potential competition.

(17)There is not industry unanimity on this point. For opposing views on the success of mass marketing see Mass Marketing: Pros and Cons Arouse Controversy, SECURITY SALES, Jan. 1992, at 43-49.

(18)Statistics on the monitoring portion of the industry, unless otherwise noted, come from U.S. DEPARTMENT OF COMMERCE, BUREAU OF THE CENSUS, 1987 CENSUS OF SERVICE INDUSTRIES at PA 107,112 (1989) & 1-21 (1990).

(19)Although the Supreme Court used UL certification to define the market in Grinnell, we do not believe this to be appropriate. See Grinnell, 236 F. Supp. 244 (D.R.I. 1964), aff'd, 384 U.S. 563 (1966). In the years since Grinnell the proportion of certificated central stations has not changed. Such certification is not important for either entry or success.

(20)RBOC Asks FCC to Waive Rules to Monitor Alarms, SECURITY SALES, May 1992, at 13.

(21)The findings in U.S. v. Grinnell Corp. are at variance with our conclusions. See Grinnell, 236 F. Supp. 244 (D.R.I. 1964), aff'd, 384 U.S. 563 (1966). The majority opinion found that all segments of the industry operate nationally. Our evidence suggests the contrary. The majority opinion also defined the product market to be accredited and certificated central stations and security systems. This distinction is really only relevant to commercial users of alarm services, a small part of the total market. Correctly, the court observed that fringe firms had not been adversely affected nor driven from the market by the behavior of Grinnell and the firms in which it owned stock. Our interpretation of ADT's operation of deficit offices was a recognition of the competitive tenacity of local installer/dealers.

(22)Competition in the Telecommunication Industry: Hearings on H.R. 2030 Before the Subcomm. on Monopolies and Commercial Law of the Comm. on the Judiciary, 100th Cong., 1st Sess. 357 (1987) (statement of the NYNEX Corp.). There is also a report that Bell Atlantic is planning to test market in the Washington, DC area a total home management package including lighting, heating, and electronic security. See Jodie Girsh, Bell Atlantic to Enter Home Security Field, THE BELLRINGER, April 1992, at 21.

(23)Of course, the RBOCs would have to make their mailing lists available to alarm companies at the same price at which they would be offered to their own subsidiary.

(24)John J. Keller, Security Companies Are Alarmed by Baby Bells' Threat, WALL ST. J., July 1, 1992, at B4.

(25)Brooks Bill Could Bring Alarm Industry Relief, NATIONAL NEWSLINE, June 1992, at 1.

(26)U.S. v. Western Electric Co., Inc., 714 F. Supp. 1, 2 (D.D.C. 1988).



(29)Id. at n.4.

(30)The court stated: "It would be absurd to lift the restrictions on the provision of information content based on the theory that the Regional Companies know more about and are better able to capitalize on these businesses than those who have made these endeavors their lives work." Id. at 4.

(31)Id. at 3.

(32)U.S. v. Western Electric Co., 900 F.2d 238, 292 (D.C. Cir. 1990).

(33)This episode was reported in a sequence of articles. See John R. Wilke & MaryLu Carnevale, Wrong Numbers NYNEX Overcharged Phone Units for Years, an FCC Audit Finds, WALL ST. J., Jan. 9, 1990, at A1; MaryLu Carnevale, FCC Fines NYNEX Units $1.4 million, Orders Refund for Excess Markups, WALL ST. J., Feb. 9, 1990, at A3; MaryLu Carnevale, U.S. Audits Contradict NYNEX Assertion That It Didn't Intend to Overcharge Units, WALL ST. J., Feb. 12, 1990, at A16; Audit Says 1 NYNEX Unit Overcharged by Another, WALL ST. J., Feb. 19, 1990, at A5.

(34)U.S. v. Western Electric Co., 900 F.2d at 296.


(36)Id. at 300 (emphasis in original).

(37)U.S. v. Western Electric Co., Inc., 1991-2 Trade Cas. (CCH) [pargraph] 69,503, at 66,147 (D.D.C. July 25, 1991).

(38)Id. at 66,151.


(40)The court quoted Prof. Roger Noll:

Information services provide an especially poor candidate for BOC entry because of the complexity and diversity of the industry.... This diversity driven by the difference among consumers in the kinds of services they most desire, makes discriminatory practices, strategic cost accounting among services, and unwarranted self-dealing financially attractive to a BOC but especially difficult to prevent. Id. at 66,155.

As Noll noted, the RBOCs might gain substantial profit before regulation or litigation could rectify the situation.

(41)Id. at 66,155 n.55.

(42)Id. at 66,157 & 66,158.

(43)Matsushita Electric Industrial Co. v. Zenith Radio Corp., 475 U.S. 574, 596 (1986).

(44)The right to transmit television signals has been granted by the FCC. Edmund L. Andrews, Telephone Companies to Get Right to Transmit Television, N.Y. TIMES, July 17, 1992, at A1, D7. In fact, USWest and Time Warner Communications are jointly promoting telephone and cable TV systems. The joint operation can exploit economies of scope which will shorten investment recovery from 10 to 5 years. Geraldine Fabrikant, Present at the Merger of Phone and Cable TV, N.Y. TIMES, May 18, 1993, at D1, D20.

(45)Some regulators, commentators and RBOC competitors take the position that the telephone companies want to use phone subscribers to raise their venture capital before the product is available. In most other industries the customer doesn't pay for the product until it is generally available. See Edmund L. Andrews, Battle Looms Over Paying to Rewire U.S. Phones, N.Y. TIMES, June 9, 1992, at 1.

(46)Tele-Communications Inc. plans to invest $2 billion in fiber-optic cable in 400 U.S. communities by 1996. It acknowledges the possibility of two-way communication over its new network. Edmund L. Andrews, Cable Company Plans a Data "Superhighway," N.Y. TIMES, April 12, 1993, at D1 & D5.

(47)Tom Nousaine & Sharon Brant, A Case for Capital Investment, TELEPHONY, Feb. 2, 1987, at 58-60.

(48)HAKIM & BUCK, supra note 12, at 125-27.


(50)Indeed, in the one area in which the phone companies must respond to a caller, directory assistance, the RBOCs have been seeking ways to reduce operator employment.

(51)Interview with an RBOC employee who is knowledgeable about the phone companies and the alarm industry. While one might dispute the 5-year target, the $100 million in sales is plausible. At this target, alarm revenue would be only 1% of RBOC sales and would be barely noticeable in a year-to-year comparison of annual reports.

(52)This discussion and the related numbers are taken from HAKIM & BUCK, supra note 12.

(53)Houston, Miami and Denver all are in this category. For all practical purposes, police in New York City, Philadelphia and Los Angeles do not respond to most alarm systems.

(54)This is now the case in Montgomery County, Maryland, a suburb of Washington, DC.

(55)Suffolk Stops Response to Business Alarms, SECURITY DISTRIBUTING & MARKETING, June 1992, at 87.

(56)Judge Greene noted that in France the government-owned telephone company transmitted but did not generate information. See William B. Baker & Katherine M. Holden, The Revolution in Information Services? The MFJ Court Takes Action, COMPUTER LAWYER, Sept. 1991, at 26.

(57)RBOC entry becomes more plausible if it is a preemptive strike or a response to cable TV companies pursuing the alarm business as a method for increasing traffic on their own networks. See Steve Moore & Bruce Guptill, A Man of Many Parts, NETWORK WORLD, May 1, 1989, at 41, 67-70.

(58)PacTel Enters into Services Market, SECURITY DISTRIBUTING & MARKETING, July 1992, at 82.
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Author:Blackstone, Erwin; Buck, Andrew J.; Hakim, Simon
Publication:Antitrust Bulletin
Date:Sep 22, 1994
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