Regulation and Entry into Telecommunications Markets

Citation

Brock, G.W. (2003), "Regulation and Entry into Telecommunications Markets", info, Vol. 5 No. 3, pp. 75-76. https://doi.org/10.1108/info.2003.5.3.75.12

This is a careful theoretical study of the economic characteristics of entry into telecommunications markets. The authors build on an extensive set of theoretical insights into network industries in general and telecommunications markets in particular. They most directly utilize Laffont and Tirole (2000) and Laffont et al. (1998a,b), but incorporate results developed by a wide variety of authors.

The innovation of de Bijl and Peitz is to use a computational approach to explore more specific cases than previous theoretical examinations. While most economic theory seeks a model amenable to mathematical derivation of qualitative results, de Bijl and Peitz make their models more specific and explore the effect of changing various parameters and assumptions by computing alternative numerical equilibria. The parameters of the model and the various cases are determined by current telecommunication controversies and empirical facts, but there is no attempt to empirically test the results of the model against observations of telecommunication prices and market shares.

After an introduction, Chapter 2 provides an impressive summary of the current state of telecommunications technology and markets, and of economic insights into telecommunication markets. The authors pack a great deal of information from a wide variety of sources into a readable 28 pages.

Chapter 3 provides a formal description of their model and their computational approach, along with initial results. It is the most critical chapter in the book because remaining chapters are elaborations and variations on the model developed here. In the basic model, there are two operators; an incumbent with a large market share and an entrant with a small market share. Each operator has a full physical network capable of reaching all customers. The networks are interconnected so that any customer can reach any other customer regardless of the network to which the customer subscribes. Each customer subscribes to one and only one network. Networks compete in two‐part tariffs charged to consumers. Each network also sets an access price that must be paid by the other network for all calls sent across network boundaries for termination. The access prices are set exogenously by regulation or other means rather than being used as a decision variable in the game. Calls are made to all other customers with equal probability, resulting in balanced incoming and outgoing traffic across network boundaries. Customers have a brand preference for one network or the other and a cost of switching among networks.

The (Nash) equilibrium is characterized by a set of two‐part tariffs for each operator (a subscription fee and a price per minute) such that each operator maximizes profits given the other operator’s choice of prices, while consumers choose a network and quantity of call minutes to maximize net utility given the set of operators’ prices. When there is asymmetry between the operators, the first order conditions for equilibrium contain polynomials of degree 3 that cannot be solved analytically but can be solved by numerical methods after specifying appropriate parameters. The authors choose parameters that “resemble cost and demand structures in a relatively small‐sized country such as The Netherlands,” but find that “the levels of cost and demand parameters, if chosen within reasonable ranges, do not affect the qualitative implications of the model” (pp. 56, 57). By computing equilibria for various cases, the authors are able to develop a number of specific qualitative conclusions such as: “In an infant market, an access markup only for the entrant increases consumers surplus and the entrant’s profits” or “In a mature market, a reciprocal access price can be used as an instrument of tacit collusion” or “a price cap on the incumbent’s subscription fee … leads to a distortion in the incumbent’s per‐minute price, and also reduces the entrant’s profits” (p. 77).

The remainder of the book adds various complications and extensions to the model developed in Chapter 3 and computes numerical equilibria to derive implications of the more complex models. Chapter 4 considers multiple periods by using a repeated version of the static basic model. It is a particularly simple approach to dynamic modeling in which the operators are assumed to maximize profits in each period without performing the more complex dynamic optimization over capital investment and market shares. Chapter 5 introduces non‐facilities based entry, including entry with a combination of owned facilities and facilities acquired from the incumbent through local loop unbundling. Chapter 6 examines the effects of allowing pricing structures other than a two‐part tariff, including discrimination between on‐net and off‐net calls. Chapters 7 and 8 extend the model to a segmented market with consumer heterogeneity and consider various entry strategies such as targeting only business customers while ignoring residential customers. The analytical and numerical methods developed for the basic model are applied to the more complex models and corresponding qualitative conclusions are reached.

This is a useful addition to the theoretical literature on telecommunications. The authors’ use of computational techniques allows resolution of much more specific questions than typical theoretical analysis. That resolution comes at the cost of specifying particular parameters and therefore creating uncertainty regarding how robust the results are to different parameters. The book is quite technical and a full understanding of it requires a similar background in economics and mathematics to that required to understand theoretical articles in economics journals. Less technically‐oriented readers can benefit from the introductory material, the results summaries in each chapter, and the conclusion, without following the details of the mathematical formulations. I believe that the most significant contribution of this book is methodological. It provides a comprehensive example of the use of numerical computations to reach conclusions from models that would be considered intractable with more standard analytical tools. While the specific conclusions from the models in the book are dependent upon the particular formulation provided and should not be considered general lessons for direct application to policy, the book provides a guide on how to set up and solve alternative models that can be developed to provide insight into particular policy problems.