Review of Industrial Organization
13: 637–649, 1998.
1998 Kluwer Academic Publishers. Printed in the Netherlands.
Optimal Local Exchange Carrier Size
SUMIT K. MAJUMDAR
University of Michigan, Business School, Ann Arbor, MI. 48109, USA
Department of Accounting, National Chengchi University Taipei, Taiwan, R.O.C.
Abstract. Optimal ﬁrm size and patterns of returns to scale among the local exchange companies in
the U.S. telecommunications industry are estimated for the years: 1975, 1978, 1981, 1984, 1987 and
1990. The independent companies display increasing returns to scale, while the Baby Bells display
constant or decreasing returns to scale. The independent companies operate at a scale smaller than
optimal size, while the Baby Bells operate at a scale greater than optimal size. Efﬁciencies can be
gained by industry restructuring, by allowing independents to expand their size while the Baby Bells
can be downsized to create smaller units.
Key words: Returns to scale, local exchange carriersize, downsizing.
JEL Classiﬁcation: L 96 (telecommunications).
Whether economies of scale exist in a particular industry is an important strategic
issue, since their existence determines minimum efﬁcient scale size and the amount
of investment required to enter a sector. Large changes have occurred in many parts
of the telecommunications industry, with increasing overlays between sectors such
as switching and transmission. It has been suggested that parts of the industry have
become naturally competitive; returns to scale patterns might be changing so that
several competitors of similar size can coexist, making local exchange markets
competitive (Bolter, McConnaughey and Kelsey, 1990; Shepherd, 1983).
In the above context, Greenwald and Sharkey (1989), after examining the
potential competitiveness of the local exchange sector, conclude that the forces
of technology have altered the basis of competition and, thereby, the continuing
justiﬁcation of local monopoly existence. However, the recent evidence available
on scale economies in the U.S. local-exchange sector is mixed. Dalton and Mann
(1988) suggest that scale economies exist, while Guldmann (1990) and Shin and
Ying (1992) suggest that breaking up the monopoly outputs of local exchange
companies may be beneﬁcial, and competition can be increased. However, such
prognostications are based on somewhat older data; for the year 1982 (Dalton and
Mann, 1988), the year 1980 (Guldmann, 1990) and for the period 1976 to 1983