Class 4 Wrap Up and Takeaways GSB 42201: The Legal Infrastructure of Business Market Power: Network Industries Randal C. Picker Leffmann Professor of Commercial Law Senior Fellow, The Computation Institute The Law School The University of Chicago Copyright © Randal C. Picker. All Rights Reserved.

Natural Monopoly Economics n Underlying technology matters u Cost function can push to having only a single facility or producer u But even with that technology, we don’t know how many competitors we will have t Depends on game that will emerge with entry t Cournot type quantity game may lead to multiple firms in industry May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.2

Natural Monopoly Pricing n Two Issues u Above MC Pricing Loses Welfare u MC Pricing Causes Insolvency n Two Approaches u Ramsey pricing u Two-part pricing May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.3

Terminal Railroad n Classic Antitrust Case n Raises questions on the right organizational structure for shared facilities n Joint ownership? Joint management? Nondiscrimination in access rules? May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.4

May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.5 Rate of Return Regulation n Investors face regulatory risk u Assets can’t be switched to other uses easily u Given natural monopoly status, price regulation a frequent response n The Political Dilemma u How does the gov’t commit to investors that it will not expropriate after the fact through rate setting?

May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.6 Rate of Return Framework Revenue Requirements = Operating Expenses + Rate of Return Rate Base x () (b)(3): “Ascertain such public utility’s reasonable operating expenses, including actual investment currently consumed through reasonable actual depreciation” (b)(1): “Ascertain the reasonable original cost of the public utility’s property used and useful, or to be used and useful within a reasonable time after the test period, in providing the service rendered to the public within the State, less that portion of the cost which has been consumed by previous use recovered by depreciation expense” (a): “the Commission shall fix such rates as shall be fair both to the public utilities and to the consumer”

Modern Access Regulation n 1996 Telcom Act as Leading Example u Identify natural monopoly aspects of industry and create access regime for those u Unbundled network elements with access at favorable prices u Jump start competition in local telcom n Success? u Not so much and intermodal competition much more important May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.7

Non-Discrimination Regulation n Network Neutrality Regulation as Modern Spin on Terminal Railroad u What is a legitimate basis for discriminating in access? Quality of service discrimination? Ownership source? u Should we apply these ideas to changes in the Twitter API and if not, why not? May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.8

Standard Setting n Modern Networks are often Virtual u Organized around industry joint standards of the sort that we saw in the DVD materials u Often cases where only one standard will be present importantly in the market place u Design of standard will create ex post market power for patents u Control that through upfront May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.9

Standard Setting u Control that through upfront commitments on pricing such as RAND and FRAND u The vagueness of those commitments can create strategic opportunities u DOJ makes that concrete in the smartphone patent closing letter May 3, 2015The Legal Infrastructure of Business. Copyright © Randal C. Picker.10