Transcript The Economics of Telecommunications Industry: A Very Brief

The Telecom Act, State Action,
and the Realization and Prospects
for Competition
George S. Ford, PhD
Chief Economist
Phoenix Center
[email protected]
The Present Uncertainty
• Technology, FCC actions, court decisions,
and the election have created considerable
uncertainty for telecommunications policy
– VOIP, Cable Telephony, Broadband over
Powerlines
– Triennial Review Order, USTA Decision, Brand
X
– Election
A Sure Thing
• Regardless of uncertainty, current focus of
modern utilities policy is the promotion of
competition
A Sure Thing
• An Act [t]o promote competition and
reduce regulation in order to
– secure lower prices and higher quality
services for American telecommunications
consumers
– and encourage the rapid deployment of
new telecommunications technologies.
What is Competition?
• Competition has many characteristics and
definitions, but competition always requires
that there be more than just one firm
offering goods/services to consumers
Benefits of Competition
Innovation
Price
Competition => Number of Firms (N)
The Policy Objective:
The End of the Monopoly
ONE
FIRM
Present
Entry by New Firms
MANY
FIRMS
Future
How Many is Many?
• There exist an equilibrium number of firms
in an industry (N*).
• N* is related to:
– Size of the market (bigger market, bigger N)
– Sunk Entry Costs (higher cost, fewer N)
– Degree of Price Competition (more
competition, fewer N)
Entry Fee (F)
• Sunk Costs
– Costs that cannot be recovered once incurred
•
•
•
•
•
Akin to a non-refundable deposit
Network Deployment
Marketing
Product Development
Regulatory Compliance
– May be Endogenous
• Caused by Incumbent
• Caused by Regulator
Simple Example
•
•
•
•
•
Market Size (S) = $1,000,000
Variable Cost (C) = $10
Entry Fee (F) = $100,000
Monopoly Price (P) = $100
Each Additional Firm Reduces Price-Cost
Margin by 10%
– Monopoly Margin is $90 = $100 - $10
– 2 Firm Margin is $81 = $90 - 90(0.10)
This example is a simplification of the analysis presented by Sutton in Sunk Cost and Market Structure (1991).
Equilibrium Number of Firms
Firms (N)
1
2
3
4
5
6
7
8
Price
100.0
90.00
81.00
72.90
65.60
59.00
53.10
47.80
Profit
800,000
344,444
192,181
115,706
69,517
38,442
15,976
-1,134
Simple Example: Alternate
Assumptions
•
•
•
•
•
•
S = 1,000,000
C = $10
F = $100,000
PM = $100
Competition = 10%
N* = 7
•
•
•
•
•
•
S = 2,000,000
C = $10
F = $100,000
PM = $100
Competition = 10%
N* = 12
Simple Example: Alternate
Assumptions
•
•
•
•
•
•
S = 1,000,000
C = $10
F = $100,000
PM = $100
Competition = 10%
N* = 7
•
•
•
•
•
•
S = 1,000,000
C = $10
F = $200,000
PM = $100
Competition = 10%
N* = 4
Simple Example: Alternate
Assumptions
•
•
•
•
•
•
S = 1,000,000
C = $10
F = $100,000
PM = $100
Competition = 10%
N* = 7
•
•
•
•
•
•
S = 1,000,000
C = $10
F = $100,000
PM = $100
Competition = 20%
N* = 6
Two Types of Entry Costs
• Exogenous Entry Costs (determined outside the
system)
– Some costs are just a necessary component of entry,
such as marketing, some legal expenses, licenses, office
space, network, etc….
• Endogenous Entry Costs (determined within the
system)
– Incumbents can raise the entry costs, possibly through
regulation
• Level Playing Field Rules
• Regulatory Proceedings
How Many is Many?
• There exist an equilibrium number of firms
in an industry (N*).
• This equilibrium number of firms depends
on:
– The size of the market in expenditures (+)
– The size and nature of production cost (-)
– The intensity of price competition (-)
What Can be Done about Entry
Costs? Advice from Economists
• The single most important element in the design of
public policy for monopoly should be the design of
arrangements which render benign the exercise of
market power associated with operating sunk facilities.
One way to avoid the exercise of monopoly power is to
have the sunk costs borne by the government or
municipality … or by mandating that sunk costs be
shared by a consortium. … Virtually any method will do
as long as there are contractual or other arrangements
that are nondiscriminatory and permit easy transfer or
lease or shared use of these cost commitments. E.
Bailey, AER, 71 (1981).”
What Can be Done about Entry
Costs? Advice from Economists
• One of the main points that emerges from the discussion
is that sunk costs are often not pervasive in an industry,
but rather are centered in a particular sector of its
operations, such as airports in air transportation. By
isolating the activities with which the heavy sunk costs
are associated, their damaging consequences can be
quarantined. By placing relations with the remainder of
the industry at arm’s length … it may be possible to leave
the operations of the bulk of the industry safely to the free
market, drawing a regulatory net over only the segment of
the activities of the industry that are inextricably
associated with heavy sunk costs. Baumol, Panzar,
Willig, Contestable Markets (1988), at 483.
Goal of the Telecom Act of 1996
“to eliminate the monopolies”
(Verizon v. FCC)
“reorganize markets deliberately” is an “end in itself”
(Verizon v. FCC)
The Act’s Strategy
Wholesale
Vertically
Integrated
Local
Exchange
Retail
Wholesale
Segment
Market for Telecom
Plant (UNEs)
Retail
Segment
Why do we need an Act?
• Industry Structure in the Local Exchange Markets
tends toward monopoly
– Economies of Density
– Sunk Costs (risk)
– First-mover advantages (i.e., municipal barriers to
entry)
– Timing of entry expenditures and realization of
revenues
– Product Differentiation (i.e., incumbent already has all
the customers)
– Vertical Integration (entry must occur at retail and
wholesale level)
The Act’s Strategy
Wholesale
Segment
Retail
Segment
N* > 0, ????
Entry economics of retail changed
dramatically with unbundling and
interconnection, since sunk network
costs were “quarantined.” Entry
economics of wholesale have
improved due to technology and law,
but the change is more subtle.
N* > 0, Relatively Easy
Where did they get this idea? …
Where Did They Get This Idea?
• Number of Toll Carriers in Year 2001 = 805
– >900 now
– Trends Report, IXCs plus resellers
• Number of Nationwide Toll Networks in Year 2001
–
–
–
–
–
–
–
–
AT&T
MCI-Worldcom
Sprint
Global Crossing (Ret. MS < 1%)
Williams (Ret. MS < 1%)
Qwest (Ret. MS < 3%)
Broadwing (Ret. MS < 1%)
Level 3 (Ret. MS < 1%)
About 100:1 Ratio of
Retail to Wholesale
Firms in Long Distance
About half of the
wholesale firms are
bankrupt (N > N*)
Getting More Wholesalers,
Facilities-Based Entry
• How do we get more wholesalers (networks)?
– In long distance, all but the three largest long distance
networks were built to serve other companies’ demands,
not the own-demand of the network owner.
– End-users don’t demand network, telecommunications
firms do.
– ILECs will serve their end-users with their own
network, so entrant’s have no demand.
– Entrant demand is from the non-incumbents serving
end users (so, we should encourage this).
Non-Incumbent Demand for
Network
• Retail LECs (RLECs) accumulate market share for
the Wholesale LECs (WLEC or ADCo).
– RLECs want multi-firm supply
– ILECs (today) are reluctant suppliers (full price is higher
than wholesale price)
• Facilities-based entry on a meaningful scale is made
more possible with successful RLECs
• RLECs cannot all be expected to deploy their own
facilities
– Consider market structure in long distance (100:1
Retail/wholesale)
Non-Incumbent Demand for
Network
• If we don’t have unbundling building as a
means to build a demand for alternative
network, how will this demand develop?
How to Use the Theory at Work
• Is the proposed policy going to increase or
decrease the market available to potential
entrants?
How to Use the Theory at Work:
Example
• FCC Restriction on availability of unbundled
switching in Top 50 MSAs.
– An Empirical Examination of the Unbundled Local
Switching Restriction, Z-Tel Policy Paper No. 3, March
2002.
– Does Unbundling Really Discourage Facilities-Based Entry?
An Econometric Examination of the Unbundled Local
Switching Restriction, Z-Tel Policy Paper No. 4, February
2002.
– Mandated Access and the Make-or-Buy Decision: The Case
of Local Telecommunications Competition, T. R. Beard, G.
S. Ford, and T.M. Koutsky, QREF Forthcoming.
How to Use the Theory at Work
• Is the proposed policy going to increase the
cost of entry, particularly those costs that
cannot be recovered?
– Is the policy debate itself raising entry costs?
– Am I, as a regulator, allowing the incumbent to
raise entry costs or contributing to the problem?
How to Use the Theory at Work
• Is the proposed policy affecting the intensity
of price competition?
– Price cuts are generally a good thing, but there
are price cuts that can harm the competitive
process
– Is the price cut intended to squash nescient
entry?
How to Use the Theory at Work:
Implications
• Given the large entry costs of facilitiesbased entry, it is unreasonable to expect a
large number of entrants.
• Observed entry does not imply successful
entry, and does not imply further entry is
feasible (there is an equilibrium N).
How to Use the Theory at Work:
Implications
• Facilities-based entry will occur when few
facilities (low entry costs) can serve large
demands (large market size)
– E.g., dedicated trunks to big businesses
– Facilities entry occurs when there is a large size
to entry costs ratio
How to Use the Theory at Work:
Implications
• Minimum market share for a facilities-based
local provider of mass market local service
is large, suggesting high concentration in
that market.
• Facilities based entrant for mass market will
require large market share (20 - 50%).
• Where will a potential facilities based entry
get 20-50% market share?
How to Use the Theory at Work:
Summary
• What does this do the market size available
to entrants?
• What does this do to entry costs?
FCC Order: Bad Economics
• Larger fixed and sunk costs imply that fewer
firms are able to survive profitably in the
industry (TRO, ¶ 80). OK
• If more facilities-based carriers have entered
the market than can be supported by market
demand, creating overcapacity and generating
low prices, none of the carriers may be
profitable (TRO, ft. 320). OK
FCC Order: Bad Economics
• Limiting our high-capacity loop triggers to only one
competitor runs the risk of failing to accommodate
unusual circumstances unique to that single provider
that may not reflect the ability of other competitors to
similarly deploy. Establishing a higher number, for
example three, would likely render our high-capacity
loop triggers meaningless for the many customer
locations where the potential aggregate customer
demand would never support more than two
competitive alternatives to the incumbent LEC (TRO,
ft. 974).
FCC Order: Bad Economics
• if there is no collocation space available for
additional competitive LEC equipment, further
competitive entry may be impossible (TRO, ¶
503).
FCC Order: Bad Economics
• We find that the presence of facilities-based
competitors is the best indicator that
requesting carriers are not impaired (TRO, ¶
498).
FCC Order: Bad Economics
• evidence of actual deployment indicates barriers to
entry can be overcome (TRO, 331)
• We establish the number of competitors to the
incumbent LEC necessary to satisfy each trigger for
high-capacity loops subject to a finding of impairment
at two in order to ensure that multiple competitive
entry at each location is feasible (TRO, ¶ 330).
The Act
• An Act [t]o promote competition and
reduce regulation in order to
– secure lower prices and higher quality
services for American telecommunications
consumers
– and encourage the rapid deployment of
new telecommunications technologies.
Lower Prices, Higher Quality?
• PHOENIX CENTER POLICY
BULLETIN No. 8: The $10 Billion
Benefit of Unbundling: Consumer
Surplus Gains from Competitive Pricing
Innovations (27 January 2004).
Investment
• George S. Ford and Lawrence J. Spiwak, The Positive
Effects of Unbundling on Broadband Deployment,
PHOENIX CENTER POLICY PAPER NO. 19 (September
2004).
• PHOENIX CENTER POLICY BULLETIN No. 6: UNE-P
Drives Bell Investment - A Synthesis Model (17
September 2003)
• PHOENIX CENTER POLICY BULLETIN No.
5: Competition and Bell Company Investment in
Telecommunications Plant: The Effects of UNE-P
(Originally released 9 July 2003 and updated 17
September 2003)
• PHOENIX CENTER POLICY BULLETIN No. 4: The Truth
About Telecommunications Investment after the
Telecommunications Act of 1996 (24 June 2003).
Investment
• Mandated Access and the Make-or-Buy Decision:
The Case of Local Telecommunications Competition,
T. R. Beard, G. S. Ford, and T.M. Koutsky, December
2002.
• Pursuing Competition in Local Telephony: The Law
and Economics of Unbundling and Impairment, T. R.
Beard, R. B. Ekelund Jr., and G.S. Ford, Journal of
Law, Technology, and Policy, Spring 2004.
• Unbundling and Facilities-Based Entry by CLECs:
Two Empirical Tests, G. S. Ford and M. D. Pelcovits,
July 2002.
Extension: Consolidation and
Entry
MARKET L
•
•
•
•
•
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S = 1,000,000
C = $10
F = $400,000
PM = $100
Competition = 10%
N* = 2
MARKET D
•
•
•
•
•
•
S = 1,000,000
C = $10
F = $100,000
PM = $100
Competition = 10%
N* = 7
Extension: Consolidation and
Entry
MARKET L
• N* = 2
MARKET D
• N* = 7
MARKET L+D
•
•
•
•
•
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S = 2,000,000
C = $10
F = $500,000
PM = $100
Competition = 10%
N* = 3
Bundling pulls the entire market
to the most concentrated element of it.
Assumes no scale or scope economies.
How to Use the Theory at Work:
An Extension
• Simple economics tells us that a bundled
local/LD/Data market will be more
concentrated than the long distance market,
but potentially less concentrated than the
local market.