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We examine the consequences of allowing a bottleneck input supplier to vertically integrate downstream and compete with users of the input when the input has a regulated price above cost. If the supplier maximizes the sum of short-run profits from the downstream market and input market, then allowing the vertical integration will increase social surplus, even if it causes sellers of competing differentiated products to exit the market. If the bottleneck supplier wishes to engage in predatory pricing, increasing the regulated price of the input above cost reduces the incentive to engage in predation. These questions are motivated primarily by assertions made in the public record that allowing Bell Operating Companies into long distance can be harmful if access rates are above cost.

In a critique of my paper outlining the Central Office Bill and Keep (COBAK) proposal, Wright (2001) offers two sets of conditions under which a COBAK interconnection regime would not lead to optimal utilization. While there could be conditions under which some interconnection regime other than COBAK would lead to higher social surplus measures in very simple models of telecommunications, the critique provides no evidence that these conditions would be empirically significant. This, along with the other considerations explained in the proposal and not considered in the analysis, continue to suggest that COBAK is an appropriate policy recommendation.

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