How Does the U.S. Government Regulate Natural Monopolies?
Monopolies and their anticompetitive characteristics have received significant press lately, thanks to Google, whose internet general search term service was found to be an unlawful monopoly by a U.S. federal district court.
The Google monopoly is considered a regular monopoly, the existence of which, as in Google’s case, can harm competition in the marketplace and (among other things) drive up prices for consumers. When this occurs, the U.S. government steps in to stop the monopoly and ensure other competitors can enter the market.
A different kind of monopoly — a natural monopoly — also exists under U.S. antitrust law.
In this article, we explain what a natural monopoly is, why the U.S. government allows them to exist, and why (and how) the government regulates them.
A Quick Word About Antitrust Regulation
Monopolies are creatures of antitrust law, an area of law designed to protect fair competition in the marketplace. The U.S. Department of Justice (DOJ) has explained that competition is a core organizing principle of the American economy. For this reason, the DOJ and its partner antitrust agency, the Federal Trade Commission (FTC), care about — and issue fines and penalties to stop — conduct that harms competition and consumers. Note that it’s competition that antitrust law seeks to protect, not competitors.
What Is a Regular Monopoly?
A regular monopoly exists when a single business has substantial market power in a given industry. The FTC has explained that this doesn’t mean the business must be the sole producer or seller of a good or service in a given industry, but only that it must have “significant and durable market power.” For example, Google was recently found to have monopoly power in the general internet search term market, even though it was not the only provider of such services. Because of their capacity to harm market competition through predatory pricing (among other things), regular monopolies are prohibited by Section 2 of the Sherman Antitrust Act, and monopolistic firms such as Google are fined and penalized under that Act.
What Is a Natural Monopoly?
The U.S. Court of Appeals for the Eighth Circuit has described a natural monopoly as “a market that can practically accommodate only one competitor.” Markets that give rise to a natural monopoly are ones with such high barriers to entry that only one company manages to enter and operate efficiently in the market.
Classic examples of traditional natural monopolies include public utilities (gas, electricity, water) and railroads (landline telephone service was once considered a natural monopoly, but this ended with the 1980s breakup of AT&T).
The types of market barriers that can lead to a natural monopoly include:
High fixed costs: Where the fixed costs of supplying a good or service are so high that it’s unlikely more than one competitor will enter the market. The utility sector is an example. Note that a provider that controls a particular market may not control the entire industry. For example, one water company may control services in a particular local market while other companies operate in other markets.
Unique resources: Where the product or service requires specific raw materials or other resources. For example, one of the reasons railroads are natural monopolies is that a railroad requires land for tracks. (Another reason is their high fixed costs.)
Economies of scale: When large-scale production is much more efficient, small-scale producers cannot compete. For example, once a water company has a completed system of pipes in an area, the cost of adding water service to additional homes is low, whereas a second company's cost to add a new system in the same area is prohibitively high.
First-mover advantage: The first company to bring a product or service to the market gains a competitive advantage. For example, once a utility company installs a power grid in a region, it makes little sense for a second company to put another grid in the same area.
Does a Natural Monopoly Violate Antitrust Law?
No, not on its own. Like regular monopolies, natural monopolies are not unlawful on their own; a natural monopolist violates antitrust law only when it engages in anticompetitive behavior.
Indeed, the DOJ has said that some natural monopolies make sense for the marketplace because in situations where market entry is significantly costly, it may be more efficient (and thus less costly to consumers) to have a single entity supply the market.
Why Does the U.S. Government Regulate Natural Monopolies?
While the government may require regular monopolies to break up because adding more competitors will help consumers, the breakup of natural monopolies may harm consumers because a single company might be able to deliver the goods or services at the most economical price.
Because of this, the government allows natural monopolies to operate, but it regulates them to ensure they don’t morph from helping consumers to harming them through conduct such as:
Price exploitation
Restricted access to goods or services either for all consumers or (through discriminatory practices) certain groups of consumers
Lower quality of goods or services, including as a result of a lack of innovation
In this way, a natural monopoly can be viewed as a regulated monopoly. To the extent a utility or other natural monopoly is owned by the government (such as Amtrak®), it can be seen as a government monopoly.
How Does the U.S. Government Regulate Natural Monopolies?
In the U.S., natural monopoly regulation occurs at both the federal and state levels.
Federal Regulation
At the federal level, regulation is achieved through regulatory bodies specific to each industry, antitrust laws, and policy reform.
Industry Regulatory Bodies
Examples of industry regulatory bodies include:
Railroads: All passenger and freight rail travel in the U.S. is regulated by the Federal Railroad Administration, which is part of the Department of Transportation. In addition, the Surface Transportation Board is a federal agency that oversees economic regulation of freight rail. As for passenger trains, the U.S. government is the majority shareholder in Amtrak and sets fares based on what each geographical market will bear.
Utilities: The Department of Energy, through the Federal Energy Regulatory Commission (FERC), regulates the interstate transmission of oil, electricity, and natural gas. Regulation of interstate transmission rates and review of certain mergers and acquisitions by companies involved in the interstate sale of these commodities are included in FERC’s purview.
Antitrust Laws
Antitrust laws are enforced through both litigation and monitoring.
Antitrust litigation: The DOJ and/or FTC can bring antitrust actions against any natural monopolies that the agencies believe are engaging in anticompetitive conduct. If such conduct is found, the government can issue fines and penalties, including requiring a breakup of the natural monopoly (such as the famous breakup of AT&T mentioned above).
Antitrust monitoring: Because mergers or acquisitions involving significant market leaders could lead to natural monopolies, the government monitors such transactions.
Under the Hart-Scott-Rodino (HSR) Act, the government established a premerger notification program under which parties to certain large mergers and acquisitions must provide merger information and wait for government review and approval before they proceed with the transaction. The DOJ and FTC have established detailed Joint 2023 Merger Guidelines to assist them (and potentially merging parties) in determining whether a proposed merger has anticompetitive impacts.
Competition Policies/Reform
The federal government may also develop market reform policies to introduce competition into a natural monopoly if it feels this would benefit consumers.
State Regulation
Industry regulation also occurs at the state level. For example:
Railroads: While federal law generally preempts state law regarding the economic activity of railroads, local governments have limited authority to regulate public safety aspects of railways, which include regulation of traffic laws at railway crossings, development of local property for railroad use, and investigation of local railway accidents. For example, state regulation of railroads in California, Indiana, and Connecticut is governed by the Rail Safety Division of the California Public Utilities Commission (CPUC), the Indiana Department of Transportation, and the Connecticut Department of Transportation, respectively.
Utilities: As the Environmental Protection Agency has explained, state public utility commissions (PUCs) — such as the CPUC, the Indiana Utility Regulatory Commission, and the Connecticut Public Utilities Regulatory Authority — regulate the sale of retail electricity and natural gas, telecommunications, water, and wastewater utilities. These commissions also ensure that “utilities provide reasonable, adequate and efficient services to customers at just and reasonable prices.”
The Future of Natural Monopoly Regulation
Future lawyers interested in antitrust law should familiarize themselves with the regulations applicable to both regular and natural monopolies as well as the laws that prohibit other types of anticompetitive conduct.
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