Structural Separation and Divestiture

Two other approaches, namely structural separation and divestiture, have been used by competition authorities and telecommunications regulators in cases of serious anti-competitive cross-subsidisation. Both approaches tend to be used only where there is evidence of significant anti-competitive conduct. This usually involved not only cross-subsidisation, but related conduct such as predatory pricing, anti-competitive use of information and discriminatory practices.

Structural separation generally refers to be the separation of different lines of business of a telecommunications operator into separate corporate entities.

As an example, a cellular business can be operated by a separate company from a wire-line telephone business. Both may be owned by the same shareholders. However, existence of a separate cellular company makes it easier to ensure that the incumbent operator with which it is affiliated does not discriminate unfairly against cellular competitors as compared to its own cellular operations. Rules can be established to ensure that both cellular companies are treated the same, for example, with respect to interconnection charges. Other examples of telecommunications line of business that are frequently separated include ISPs and various types of mobile operators.

When structural separation is mandated by regulation, the different companies must typically be run on an arm's length basis. In that case, the companies must deal with each other on the same terms and conditions as they deal with third parties, such as competitors. The separate companies must normally not only have separate accounting records, but also separate management, offices, facilities, etc.

Regulatory conditions normally determine the degree of separation required in the companies' operations. Development of these conditions can pose challenges. Regulators must balance two competing objectives. One is to create sufficient separation to minimise the potential for cross-subsidisation, collusion or other anti-competitive actions between the separated companies. The other is to minimise the inefficiencies that will almost inevitably be created by structural separation.

For example, there may be efficiencies (economies of scale and scope) inherent in providing common administration services to both companies. On the other hand, the sharing of administrative services, such as accounting services, provides potential for anti-competitive conduct and for developing covert cross-subsidies. Similarly, sharing head office space can lead to efficiencies. On the other hand, it provides opportunities for collusive conduct between managers of the two companies. If structural separation is to be required, there should be a real separation of the two lines of business, including their management, premises, customer data bases, accounts and operations. Otherwise, the structural separation may be a sham.

The initial question, however, is not whether there should be structural separation between the companies, but whether the advantage of separation outweighs the disadvantages given the realities of a particular market. Other disadvantages of structural separation include high transaction costs (the costs of creating the separate companies) and the distraction for employees and customers as they work through the separation. Despite those disadvantages, structural separation may be the only way to ensure a level playing field for competition in some markets.

Structurally separate companies can often continue to operate under common ownership. Divestiture refers to a situation where a company, such as an incumbent, not only runs a particular line of business through a separate company, but divests (i.e. sells) some or all of the ownership of that separate company to independent parties.

Some competition advocates argue that only divestiture of ownership can ensure that a separate company is run in the interest of its separate shareholders, rather than merely as an operating arm of its parent company (e.g. the incumbent). Without divestiture, it is argued, a great deal of regulatory effort will be expended to detect anti-competitive dealings between affiliated companies. Once there are separate shareholders, the management of the separate companies must act in the interests of those shareholders. It will be safer to assume that the companies are actually run on an arm-length basis.

Structural Separation: The EU Cable Directive

An example of a structural separation directive can be found in the EU's 1999 Cable Ownership Directive. This Directive requires dominant telecommunications operators to place their cable television operations in a structurally separate company. The Directive builds on the EU's ONP Directive and other efforts to implement a competitive framework for telecommunications. It is intended to address specific problems which the EU Commission has concluded result from the joint operation of cable television networks and conventional telecommunication networks.

The Cable Ownership Directive makes it clear that the Commission views structural separation as the minimum corrective measure required at this time, and that it may impose further measures, including divestiture of cable interests to third parties, in specific cases. The Commission also appears to be adopting a practice of requiring dominant companies to divest their cable interests as a precondition to securing Commission approval for new mergers among telephone companies.

Divestiture: The AT & T Model

The most famous example of a telecommunications divestiture involved the separation of AT&T from the Regional Bell Operating Companies (RBOCs) in the United States in 1984. Not only were the local operations of AT&T structurally separated from its long distance and international operations, but ownership of the two groups of companies was separated by means of a share swap. The divestiture was, by most accounts, a great success.

With their ownership separate from AT&T, the RBOCs no longer had an incentive to favour AT&T over its long distance competitors, such as MCI and Sprint. Therefore, all long distance competitors obtained access to local telecommunications services from RBOCs on similar, non-discriminatory terms. More relevant to this section, the divestiture eliminated concerns about anti-competitive cross-subsidies between AT&T's local and long distance operations.

Divestiture is generally viewed as an extreme remedy that is only appropriate in cases of overwhelming dominance by very large operators in large economies such as the US. Policy-makers in other countries have been reluctant to consider dismembering the incumbent, which is often seen as a "national champion".