Competition, Regulation, and Broadband Access to the Internet Georg Götz Justus-Liebig-Universität Gießen
Basics • Broadband internet access – Speed > ISDN (2*64kbit/s) – Always online – ADSL (Asymmetric Digital Subscriber Line) – Cable modem • (Geographic) Coverage – “DSL Coverage” refers to the percentage of the population depending on a Local Exchange equipped with a DSLAM • Penetration – subscribers per 100 inhabitants 2
EU 25 Broadband penetration rate (January 2005) 3
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Coverage of DSL networks as % of population, January 2005 5
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“the gap between coverage in rural areas and national average is particularly significant in Slovakia, Italy, Latvia and Germany ” Broadband Coverage in Europe Final Report, idate, October 2007 7
Regulation and Competition • Very different market shares of the various technologies – D: ¼ of of connections via ULL, Penetration 20% of households, Coverage < 90 %, cable ~ 2,5% – CH: no ULL, Penetration 45 % der Haushalte, Coverage 98 %, Kabel ~ 40% • D: Regulatory holidays for VDSL? – Commissioner Viviane Reding • “I welcome that in spite of considerable political pressure, the German regulator has proved its independence by proposing to the Commission, as required by EU law, to remedy the well-known competition problems on the German broadband market (…) • To open the German broadband market to competition will lead to better services and lower internet access prices for consumers. (…) • I therefore urge the German regulator to implement this remedy [bitstream access ] now without any further delay to ensure that both competitors and consumers can profit from fairer competition also in Germany.”Viviane Reding 8
Economic analysis Problem: Build a model that • Explains penetration and coverage endogenously – Taking into account competition – Taking into account differences in population density • Allows evaluation of regulatory regimes – Welfare effects of geographically uniform prices – Effect of (compulsory) opening up of incumbent‘s network on decision to invest (by incumbent) 9
The model • Many regional markets with different population densities ⇒ Continuum of “cities/regions”, ranked according to population density s ⇒ linear relation between “number” of cities and their population density Population density s – s Regions in increasing order 10 of population density – 0 s
The model • Demand y ( s ) in regional market s : – Each household has unit-demand for broadband access, households differ w.r.t willingness to pay ⇒ Maximum willingness to pay: a , number of households: a s ⇒ Linear demand function: y = s ( a – p ) Price p a Demand y ( s ) in region with poulation density s Demand y ( s 1 ) with s 1 < s Demand y 11 0 as 1 as
The model • Further assumptions: – fixed investment f necessary to allow for DSL at a certain exchange – Costs per subscriber: c – Regional market structure: no, one or two providers – Duopoly case: linear demand functions with differentiated products (linear-quadratic utility function) – Two-stage game: • investment (=coverage) decision (all firms) • Bertrand price competition 12
Benchmark: Coverage and penetration in unregulated monopoly • Pricing in covered markets Monopoly price p M = ( a + c )/2 ⇒ ⇒ Profit in market s : Π M ( s ) = s ( a – c ) 2 / 4 • Decision to invest: ⇒ Build network � Π M ( s ) ≥ f Smallest covered market s : s M = 4 f / ( a – c ) 2 ⇒ • Broadband penetration Y _ Y M = s 2 ( a – c ) / 4 – 4 f 2 / ( a – c ) 3 ⇒ 13
Regulated monopoly: price cap and service-based competition, resp. • Regulator determines price cap/wholesale price p ⇒ Profit im Markt s : Π R ( s ) = s ( a – p ) ( p – c ) • Incumbent‘s decision to invest: ⇒ Invest � Π R ( s ) ≥ f ⇒ Smallest covered market s : s R = f /(( a – p ) ( p – c )) ≥ s M • Penetration level Y _ Y R = s 2 ( a – p ) / 2 – f 2 / (2( a – p ) ( p – c ) 2 ) ⇒ 14
Unregulated vs. regulated monopoly: An example _ • a = 100, c = 0, s = 1000, f = 500 000 ⇒ Potential market: 50 000 000 HH and users, resp. • Unregulated monopoly p M = 50, s M = 200, Y M = 24 000 000, ⇒ ⇒ Penetration: 48%, Coverage: 96% of HH 15
Penetration and coverage as a function of price cap p Penetration Y s 40 Mio. 1000 800 30 Mio. 600 20 Mio. 400 10 Mio. 200 p p 10 20 30 40 50 10 20 30 40 50 • Penetration initially increases with decreasing prices. However, as the price cap beccomes very low, penetration eventually decreases. ⇒ Price decrease increases demand in covered regions ⇒ Monopolists invests less and coverage and number of potential consumers decreases 16
Unregulated vs. regulated monopoly: An example _ • a = 100, c = 0, s = 1000, f = 500 000 ⇒ Potential market: 50 000 000 HH and users, resp. • Unregulated monopoly p M = 50, s M = 200, Y M = 24 000 000, ⇒ ⇒ Penetration: 48%, Coverage: 96% of HH • Regulated monopoly (maximum penetration) p RP = 17,6, s RP = 345,3, Y RP = 36,3 Mio., ⇒ ⇒ Penetration: 72,6%, Coverage: 88,1% of HH • Regulated monopoly (maximum welfare) p RW = 21,2, s RW = 299,6, Y RW = 35,9 Mio., ⇒ 17 ⇒ Penetration: 71,8%, Coverage: 91,0% of HH
Side remark: The impossibility of cost oriented access charges • Remark: – Regulation of access charges and rental rates in EU is cost- oriented (FLRIC: Average cost in economic terms) and geographically uniform ⇒ Effect of such a regulation (in the model): The monopolist does not invest! ⇒ Reason: Independent of level of investment (i.e. independent of s ), (more than) 50 per cent of the markets would not break even! ⇒ Markups on average costs in cases of optimal regulation are large! ⇒ p RP = 17,6; AC RP = 9,0; ⇒ p RW = 21,2; AC RW = 9,8. 18
Facilities-based competition (duopoly) Inverse demand (Duopoly) ⇒ p 1 = a – x 1 – σ x 2 Population density s ⇒ p 2 = a – x 2 – σ x 1 – s with σ∈ [0,1] Price competition (given coverage) - no regulation ⇒ Monopoly: p M – 0 Orte s s C s D = p 2 D = p D ⇒ Duopoly: p 1 Duopoly Monopoly a (1 – σ ) + c = 19 2 – σ
Facilities-based competition (duopoly): geographically uniform prices (UP) Price competition (given Population density s coverage) – ⇒ p M ≥ p 1 UP ≥ p 2 UP ≥ p D s UP decreasing in ⇒ p 1 UP , p 2 μ ⇒ Für large σ (> 0.8) only D M equilibria in mixed strategies exist! – 0 Orte s s C s UP may increase, ⇒ p 1 Duopoly UP , p 2 Monopoly if σ increases! Share μ of the duoply segment: μ ≡ D ⁄ (D + M) 20
Broadband penetration under facilities based competition Key parameter: Degree of product differentiation σ Penetration Y (Mio) Unregulated Geographically uniform prices reg. Monop., σ max. penetration 23
Broadband penetration under facilities based competition Key parameter: Degree of product differentiation σ Penetration Y (Mio) Symm. Regulation with p RW Unregulated Geographically uniform prices reg. Monop., σ max. penetration 24
Welfare under facilities-based competition Welfare unregulated – Welfare UP € (Billions) 2.8 € (Mio.) Unregulated 2.6 geogr. uniform 5 prices 2.5 2.4 σ 0.1 0.2 0.3 0.4 0.5 0.6 0.7 - 2.5 2.2 - 5 σ - 7.5 0.1 0.2 0.3 0.4 0.5 0.6 0.7 - 10 W RW 1.8 25
Welfare under facilities-based competition € (billion) W RW Unregulated geogr. uniform prices σ 26
Welfare under facilities-based competition € (Milliarden) Regulated (inclusive cable) W RW Unregulated geogr. uniform prices σ 27
Subsidizing broadband access – supply side Welfare in € Subsidization of incumbent Subsidy/ Exchange(€) 28
Subsidizing broadband access – supply side Welfare in € Subsidization of incumbent Subsidization of both firms Subsidy/ Exchange(€) 29
Subsidizing broadband access – demand side Welfare in € Subsidy/ Household (€) 30
Conclusions • Low prices are “costly” : – Negative effect on investment – Regions with low population density are particularly bad off – Cost oriented, geographically uniform prices destroy incentives to invest • Negative effects of policy focusing on service-based rather than facilities-based competition cannot be compensated by optimal regulation of “bottleneck” – Problem if (horizontal!) networks are not unbundled – Licensing of potentially competing network infrastructures to incumbents 31
Conclusions • Simple regulatory rules as “safeguards” – (e.g. geographically uniform prices as an instrument to provide “predation”/entry deterrence by incumbent ⇒ Minimal invasive regulation to ensure effective competition! • Welfare (in the model) is only slightly higher under “optimal” (benevolent, omniscient and costless) regulation than under facilities-based (platform) competition • Uncertainty and asymmetric information • Regulation is costly and produces regulatory risk ⇒ If facilities-based competition is “possible”, desirability of regulation (except safeguards) less than obvious! 32
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