The Arbitrage between Service and Infrastructure Competition in the Light of the "Ladder of Investment" Theory (original) (raw)

Abstract

The first part presents the main economic mechanisms related to the alternative "infrastructure/service", the theoretical basis on which these mechanisms rely and the related regulatory schemes. M.A.Bergman discusses the trade-offs between competition in the entire value chain that comes from infrastructure-based competition and the economies of scale from access-based competition, as well as how balance is affected by the choice of a specific regulatory model. He demonstrates that while Infrastructure-based competition potentially offers less regulationinduced inefficiencies, service-based competition allows the industry to realize greater returns to scale (including network effects). He reviews a number of regulatory options, such as vertical separation, government ownership and access regulation, and analyses their implications in terms of desirability of competition on infrastructure. A.Henten and K.E.Skouby discuss the theory of 'the ladder of investment' in broadband access. This theory states that the entry of players on the market occurs on a step-by-step basis ('rung-wise'). Players enter the market in areas where barriers to entry are low and, later in the process, enter areas with higher barriers. A frame-setting discussion on both the theory and the environment in which it has developed is proposed, highlighted via three country cases (the UK, the US, and Denmark) and emphasises how these countries approached the facility-based vs. servicebased competition issue. J.Kittl, M.Lundborg and E.O.Ruhle propose a panorama of the implementation of unbundling by National Regulatory Agencies across Europe and the related impact in terms of economic welfare. This study points out the importance of a balanced approach: it seems that there is no single way towards competition, but that markets need a healthy mixture of both service-based and infrastructure-based competition. They also show that, with convergence and new technologies like broadband and VoIP, access at the levels of networks, services, applications and devices and own infrastructure and thus LLU will become increasingly important for operators to be able to differentiate their products. U.Blum, N.Krap and C.Growitsch starting point is the announcement, in summer 2005, of Deutsche Telekom to precondition a 3 billion euro investment in a fibre optic network not to be regulated with respect to pricing and third party access. Unless the new technologically-leading infrastructure was exempted from regulation, Telekom threatened the investment to be made in other areas or countries. On that basis, to develop a regulator's strategy that allows investments to occur but prevents monopolistic prices, the authors model an investor's decision problem under threat of regulation and show that the mere threat of a regulator's intervention may prevent Infrastructure versus Service-based Competition: the Case of Mobile Telecommunications-11-responsive to changes in consumer preferences and led to continual improvement in service quality. L.Benzoni and P.Geoffron propose a comparative analysis of structures (in terms of number of operators) and performances (price, volume, penetration) in the European mobile markets in order to reveal an "optimal structure". It has been shown that markets with three players are those that have the most success in relation to these criteria (or, at least, that markets with four and five operators does not present obvious advantages for consumers). Without concluding that three is a "golden number", these results suggest to authorities that there is not necessarily an economic rationale to add more operators (MNOs as well as MVNOs) that will have to face the persistent first movers advantages of the incumbents. It also indicates that granting an additional license does not lead, in any circumstance, to an increase in the consumers' surplus. C.H.Vuong discusses the reasoning favouring infrastructure over servicebased competition in the context of the European mobile telephony sector. Using principally basic economics and finance toolkits, the author argues that, because of the characteristics of mobile industry (a fast changing industry with high initial irreversible investments) and the complex nature of competition in the European mobile industry, infrastructure-based competition presents more "guarantees" as regards innovation dynamics over the long term. He shows that there is no need to intervene in relationships between MNOs and MVNOs and credible regulatory threats should be sufficient for optimal market outcome, and avoid regulatory costs.

Figures (25)

Table 1. Topology of national regimes

Table 2. Decomposition of national analyses (1)

Figure 3. The Penetration Rates of Broadband Services Source: OECD Broadband Statistics, December 2006.

Table 4. Number of Wireless Operators (2005)

It is important to note that Europe uses a “calling party pays” system that bills customers for originating minutes, whereas, in the U.S. system, customers are billed for both originating and terminating minutes. This means that the U.S. system counts more minutes, which would affect the relative comparison of average monthly usage and price. Schwartz and Mini (2007) conducted an independent analysis correcting for differences in payment system and still found U.S. prices to be lower than all of the major European countries. They also make a correction for the prevalence of dormant (not active) phones in the European statistics. Their analysis also shows that U.S. prices have decreased faster as a percent or in absolute terms, compared to all major European countries (Schwartz and Mini 2007).

In general, increased facility-based competition in the U.S. market has made wireless providers very responsive to changes in consumer preferences. Considering that it is consumers that pay the bills and, when given market choices, anecdotal evidence suggests that wireless providers are indeed listening. Wireless consumers are now expressing more diverse needs and there are indications that competitors are responding by increasing the differentiation of services in order to meet those needs. Pricing solutions that attracted mainstream consumers years ago and standardized “out-of-the- box” solutions are slowly giving way to demands for specialized solutions, flexibility and service differentiation.

Figure 11. Evolution of Costs and Margins in Terms of Market Structure

Inasmuch as the unit costs are more significant within the context of a market with many firms, these firms have the tendency to compensate for these costs through prices.

TRANSPOSITION TO THE MOBILE TELEPHONY MARKET IN EUROPE Figure 13. Optimal market structure

Figure 15. Average traffic per user, according to number of operators on the national market (in 2005)

91 European Commission, “European Electronic Communications Regulation and Markets 2008” The positive results of infrastructure competition may be summarised in considering, as detailed in the next figures :

Table 5. Millions of subscribers on 2G and 3G systems In the wake of such low demand for the new technology, many operators decided to focus on upgrading the previous generation 2G systems to what came to be known as 2.5G. This interim ‘solution’ provided almost all of the benefits that 3G had promised, yet at a fraction of the cost and without the need for costly new spectrum licenses. As the label 2.5G suggests, instead of a smooth transition from the second to the third generation, the system

2G was upgraded to what came to be known as two-and-a-half generation (2.5G) or GPRS (General Packet Radio Services) through bolting on packet-switching data transmission technology onto 2G systems. Sometimes called ‘3G-lite’ in the industry, these 2.5G upgrades essentially allowed faster connections to the Internet via the mobile phone. 2.5G could handle data transmission speeds between 33.6 and 128 Kbps, as against a maximum of 2000kbps for 3G, thereby lifting the performance to a higher level than 2G but well below 3G’s performance. As 2.5G operated on the limited 2G spectrum, it could not achieve what 3G was capable of. Nevertheless it was able to close the gap in performance between the two platforms thereby generating increasing inertia to a move to 3G.

That is, radio-less “virtual” network operators that buy basic network services from radio-based “non-virtual” operators will normally do this under incomplete contracts that specify some, but not all the obligations under some, but not all future conditions. Instead of specifying every possible future decision and condition, difficulties are dealt with, and conflicts resolved, as the future unfolds. This may work reasonably well under mos‘ ordinary supply contracts as long as problems are simple and easy to solve and potential losses from switching partner are small. In situations where problems are more difficult to solve, and switching costs are large, simple contracts will no longer suffice. Should one of the parties, due to possible failures or defects by the other party wish to exit from the relation, this may not only lead to time-consuming and costly conflicts, arbitration and possible litigation, but also to the loss of all the non-redeployable assets. To avoic such transaction costs, simple contracts should be replaced by more complex contracts with stronger safeguards, such as long-term contracts, joint ventures or fully integrated corporations, dependent on the level of contractual difficulty and the size of potential losses from separation. The choice of integrated corporation should consequently be reserved for the most difficult cases with the highest loss potentials’.

Figure 22. Factors Potentially Affecting Infrastructure Development Considering the second row, the economic importance of the telecommunications industry has been among the factors contributing to the active role of governments in this sector. The reform process that has taken place in developed countries and in many low and middle-income countries aims at achieving public interest targets by a set of major policy changes, in which the establishment of a regulatory framework is accompanied by sector restructuring, the liberalization of the market and the privatization of the incumbent. Put at its simplest, introducing private finance and privatizing expanding telecommunications industries has been the main force behind the development of new regulatory organizations as well as, arguably, encouraging general improvements in country governance in the areas of commercial law enforcement.

Figure 23. Mobile subscribers per 100 inhabitants The second equation relates income levels (GDP per head) to the penetration of mobile communications, a measure of country institutions'’® and other variables. The institutional characteristics considered in this study are: (a) protection against expropriation risk (e.g. an index of constraints to the executive; see Henisz 2002); (b) financial market development (e.g. share of credit to the private sector on GDP). The key point is to test not only whether separate regulation increases mobile penetration rates but also whether higher mobile penetration rates increase income levels.

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