Vertical Integration and Media Regulation in the New Economy t Christopher S. Yoo Recent mergers and academic commentary have placed renewed focus on what has long been one of the central issues in media policy: whether media conglomerates can use vertical 'integration to harm competition. This Article seeks to move past previous studies, which have explored limited aspects of this issue, and apply the full sweep of modern economic theory to evaluate the regulation of vertical integration in media-related industries. It does so initially by applying the basic static efficiency analyses of vertical integration developed under the Chicago and post-Chicago Schools of antitrust law and economics to three industries: broadcasting,cable television, and cable modem systems. An empirical analysis reveals that the structuralpreconditions recognized by both Schools as necessary for vertical integration to harm competition do not exist in any of these industries.In addition, the cost structure of these industries suggests that vertical integration may well lead to efficiencies sufficient tojustify allowingsuch integration to occur. A dynamic efficiency analysis provides additional reasons for believing that attempts to regulate vertical integration in these industries are misguided. Growing reliance on compelled access to redress the problems purportedly caused by vertical integration threatens to dampen investment incentives in technologically dynamic industries in which such incentives are particularly important. Not only does forcing a monopolist to share an input deviate from the system of well-defined property rights needed to promote efficient levels of investment, it also deprives new entrants seeking to compete directly with the supposed monopoly bottleneck of their natural strategicpartners. The Article also engages a complex web of arguments involving the extent to which technological innovation is affected by market concentration, standardization, and network externalities. A close review of the economic literature reveals f Assistant Professor of Law, Vanderbilt University Law School. This Article benefited immensely from a workshop conducted while I was serving as a Fellow for the Center for Communications Law and Policy at the University of Southern California Law School, as well as a workshop at the 2000 Annual Meeting of the Southeastern Association of American Law Schools. I would also like to thank Ash Bhagwat, Tim Brennan, Andy Daughety, Paul Edelman, Luke Froeb, John Goldberg, Ron Krotoszynski, Mark Lemley, Ed McCaffrey, Bob Rasmussen, Jennifer Reinganum, Jim Speta, Matt Spitzer, Eric Talley, Randall Thomas, Bob Thompson, Mark Weinstein, and Phil Weiser for their helpful comments on earlier drafts of this Article, as well as Rob Mahini, Rob Schmoll, and Paul Weiner for their expert research assistance. I should also disclose that I served as a law clerk for the courts that decided State Oil Co. v. Khan, 522 U.S. 3 (1997), and Time Warner Entertainment Co. v. FCC, 93 F.3d 957 (D.C. Cir. 1996). The views contained in this Article are my own, as are any errors. Copyright © 2002 Yale Journal on Regulation Yale Journal on Regulation Vol. 19:171, 2002 that the relationship between these factors is too ambiguous to support the type of simple policy inference needed to prohibit vertical integration as a regulatory matter. The Article concludes with an analysis of the intellectual and institutional obstacles for adopting a more integrated economic approach to vertical integrationin these industries. In tro duction ............................................................................................. 174 I. The Chain Broadcasting Rules and the Basic Economics of V ertical Integration .......................................................................... 181 A. The Chain BroadcastingRules. Context, Substance, and Rationale......................................................... 182 1. The Structure of the Broadcasting Industry ..................... 182 2. The Chain Broadcasting Rules ......................................... 183 3. The Economic Theory Underlying the Chain Broadcasting R ules .......................................................... 185 B. The Basic Economics of Vertical Integration.......................... 187 1. The Chicago School's Rejection of Per Se Illeg ality ........................................................................... 18 7 2. The Post-Chicago School's Rejection of Per Se L egality .......................................................................202 C. Applying the Basic Economic Frameworkto the Chain BroadcastingRules ....................................................... 206 1. Concentration in the Market for Television N etw orks .......................................................................... 206 2. Concentration and Barriers to Entry in the Market for Home Delivery of Television Program m ing .................................................................... 212 3. Potential Efficiency Justifications .................................... 213 D. The Future of the Chain BroadcastingRules .......................... 217 II. The 1992 Cable Act and the Dynamic Inefficiency of C ompelled A ccess ........................................................................... 2 19 A. Description of the Cable Industry and the Regulatory Restrictions on Vertical Integration...................... 220 1. The Structure of the Cable Industry ................................. 220 2. Provisions of the 1992 Cable Act Affecting V ertical Integration .......................................................... 222 3. The Economic Theory Underlying the Restrictions on Vertical Integration Contained in the 1992 Cable Act ..................................... 223 B. StructuralMarket Conditions.................................................. 226 1. Concentration in the Market for MVPDs ......................... 226 Vertical Integration and Media Regulation in the New Economy 2. Concentration and Barriers to Entry into the Market for Television Networks ...................................... 230 3. Potential Efficiency Justifications for Vertical Integration in the Cable Industry ........................ 232 4. The Special Problem of Rate Regulation ......................... 237 5. Empirical Evidence on Vertical Integration in the C able Industry ............................................................ 238 C. The ProblematicNature of Compelled Access ........................ 243 1. The Relationship Between Compelled Access and Leveraging and Foreclosure T h eo ry .............................................................................. 2 44 2. The Administrability of Compelled Access ..................... 244 3. Compelled Access and Dynamic Efficiency .................... 246 D. The Future of the Vertical IntegrationProvisions of the 1992 Cable A ct ............................................................... 247 III. Open Access to Cable Modem Systems and the New Economy Theories of Technological Change .................................. 248 A. The Cable Modem Industry and the Open Access D eba te ......................................................................................2 5 0 1. The Structure of the Cable Modem Industry .................... 250 2. Regulatory Consideration of Open Access ...................... 251 3. The Economic Theory Underlying the Open A ccess D ebate .................................................................. 252 B. StructuralM arket Conditions .................................................. 253 1. Concentration in the Market for Broadband T ran sp ort .......................................................................... 253 2. Concentration and Barriers to Entry into the M arket for ISP s ................................................................ 259 3. Potential Efficiencies from Combining Cable M odem and ISP Services ................................................. 260 4. Post-Chicago Models of Open Access ............................. 265 5. The Empirical Evidence on Open Access ........................ 267 C. The ProblematicNature of Compelled Access as a R em edy ..................................................................................... 2 6 8 D. The New Economy Arguments: The Effect of Standardizationon Innovation................................................. 269 1. The Tradeoff Between Standardization and Product D iversity ............................................................. 271 2. The Relationship Between Market Concentration and Innovation .......................................... 272 3. Network Externalities and Vertical C om petition ...................................................................... 278 Yale Journal on Regulation Vol. 19:171, 2002 IV. Obstacles to an Integrated Approach to Vertical Media R egu lation ........................................................................................ 2 85 A. Misplaced Focus on Technological Differences Rather than FunctionalSimilarities ......................................... 285 B. Lack of a Comprehensive Approach to the Economics of Vertical Integration........................................... 290 C. Misconceived Analogies to Previous Legacy Monop olies .............................................................................. 29 1 C on clu sion ............................................................................................... 2 95 Introduction The megamerger between America Online and Time