Review of Industrial Organization (2006) 28:3–16 © Springer 2006
Regulation in Vertically-Related Industries:
Myths, Facts, and Policy
DAVID E. M. SAPPINGTON
Department of Economics, University of Florida, Box 117140 Gainesville, FL 32611, USA
Abstract. This paper explains why conclusions that appear to be “facts” can truly be “myths”
in industries like today’s telecommunications industry, where key suppliers operate in multiple
vertical stages of production. The paper explains, for example, why an entrant’s decision to
make or buy critical production inputs may be largely insensitive to the price of these inputs.
It also reviews why a vertically-integrated producer (VIP) may prefer to assist, rather than
disadvantage, retail rivals, and why a VIP may be disadvantaging rivals even when it provides
them with the same wholesale service quality that it provides to its own retail afﬁliate.
Key words: regulatory policy, vertically-related industries, myths vs. facts.
JEL Classiﬁcations: L51, L43, L22
Economic analysis can be of particular value to policymakers when it
delivers unequivocal predictions and offers clear policy guidance. Unfor-
tunately, simple, precise guidance can be difﬁcult to develop in industries
like today’s telecommunications industry, where key suppliers operate in
multiple vertical stages of production. In the telecommunications industry,
incumbent local exchange carriers (ILECs) such as the “Baby Bells” oper-
ate at both the wholesale and the retail stages of production. ILECs both
sell critical inputs such as the local loop
to competitive local exchange car-
riers (CLECs) and provide retail services (e.g., basic local telephone service)
directly to consumers.
Participation in multiple industry stages can complicate incentives and
actions considerably, rendering false what may appear to be obvious eco-
nomic facts. For example, a CLEC’s decision to make or buy critical pro-
duction inputs may be largely insensitive to the price of these inputs. In
The local loop is the wire that carries telecommunications messages from a supplier’s
central ofﬁce to a customer’s premises.