What constitutes competition?

That simple question is at the heart of most of the debates over how telecom should be regulated--or should not be regulated--in the U.S. going forward.

Incumbent telephone companies look around at all the cell phones and the laptops and the BlackBerrys, and see their traditional revenue base eroding rapidly. Factor in the growth of voice over Internet Protocol, and the prospects look dire.

But for most consumers, choice is still limited. To get VoIP, you need broadband service, and for that, the options are cable or DSL. Satellite and wireless combined have only 500,000 high-speed access customers out of 37.9 million high-speed access lines in the U.S., according to the most recent Federal Communications Commission report. Understandably, there are genuine concerns from consumers groups and others that a telco-cable duopoly will lead to fewer options in both connections and content for many consumers.

The definition of competition is also at the heart of a new White Paper by the staff of the New York Public Service Commission, which recommends some fairly stringent requirements for Verizon and MCI to be allowed to merge.

The NY-PSC staff took a look at how the Verizon-MCI merger would affect competition within its state for both consumers and businesses, and went one step farther to examine how the combination of the Verizon-MCI and SBC-AT&T mergers would affect New York. The staff used something called the Herfindahl-Hirschman Indices (HHI) to determine market concentration, citing the Department of Justice and Federal Trade Commission endorsement of this process to evaluate horizontal mergers.

"Those guidelines stem from the premise that as the number of competitors in a market declines, the potential for anti-competitive behavior increases," the NY-PSC staff writes in its White Paper. "Staff used data collected from various sources as a starting point to calculate market shares and Herfindahl-Hirschman Indices (HHIs) relevant to the proposed mergers.

The HHI, endorsed by the DOJ, measures market concentration and recognizes the correlation between market concentration and the lack of market competitiveness. Concentration in a market is important because the level of concentration affects the behavior of firms in the marketplace. Greater market concentration is generally associated with behavior in which firms exercising market power seek to push prices above competitive levels."

Based on the HHI numbers, however, Verizon already has a stranglehold on the telecom market for both consumer and business service in New York, and the MCI merger only makes it worse.

For example, any HHI score over 1800 indicates a highly concentrated market. Using FCC data, Verizon gets a 3912 HHI ranking in the small business and residential voice market before the merger is taken into account. That's not surprising when you consider that a decade ago, the market share of Nynex, the former Bell company now part of Verizon, was probably above 95%.

The question, therefore, is whether this HHI index is an accurate way to determine market concentration. The FCC has, of late, accepted a "sufficient competition" standard that takes into account the presence of possible competitors in a market. That approach is much more in line with the expectations of legacy service providers, which are seeing their traditional revenue base rapidly erode, but does it reflect the market reality?

The NY PSC report represents a wake-up call for other state regulators and, to some extent, to the FCC. In approving past mergers, the feds have accepted promises that weren't kept to create competition that still doesn't exist, and yet the parties involved continue to see genuine competition on other fronts.

The core question must still be answered. What constitutes competition, and when can regulators confidently say that consumers are protected?

E-mail me at CWilson3@primediabusiness.com.