Economics of Entry and
Telecommunications Regulation

Simon Wilkie
Center for Communications Law and Policy
USC Law School

D.O.J. 2007 Telecommunications Symposium

Slide 2

Overview

• Review of market definition & structure
• Economics of Regulation/Deregulation
• Issue 1 Bundled Products
• Issue 2 Market Segmentation
• Issue 3 Barriers to Entry
• Issue 4 Wireless Entry

Slide 3

Market Definition

• Challenges to traditional regulatory market definitions: Voice Cable TV Wireless
• Bundled products what is the good?
• What is market dominance in a bundle if competitors have different mix of products
• Services versus access to networks
• Market segmentation and price discrimination
• Geographic market definition and deployment
• Important to get the economics right!

Slide 4

Market Definition

• What is the product?
• Access versus Telecom Services
• Wireless substitution
• Minutes migration to wireless
• No economic evidence of access substitution
• VOIP versus POTS
• Cable entrants and others deploying VOIP
• Rapid adoption in last few years
• Minute substitution
• Number Portability Data suggests VOIP does not provide as strong a competitor for access as POTS
• Premature Deregulation may harm consumers

Slide 5

Natural Monopoly Issues

• Large Fixed Costs
• Costs are “sunk” and not reversible
• E.G. Verizon’s FIOS build
• Average unit cost falling over the relevant range
• “Dumb Pipe Paradox”
• Should expect strategic behavior
• 1996 Aims to replace regulation with competition
• Naïve deregulation may fail

Slide 6

Issue 1: Bundled Products

• Traditional Economic Model of Bundling
• Bundle substitutes to raise “stand alone prices”
• Bundled discounts
• Not that relevant telecom services
• Industry tells us driver is reduced churn
• Increase the NPV of a customer even with no change in prices

Slide 7

Issue 1: Bundled Products

• Model of “Viscous Demand” Radner 2003 JET
• Consumers don’t always look at their bills
• Transaction & Information costs
• Consumers only churn if an “event” triggers re-optimization
• Bundling increases the “shock threshold”
• Consumers have to change 3 services not 1
• Equilibrium with price dispersion
• Means welfare analysis is tricky

Slide 8

Issue 2: Segmentation and Competition Raising Prices

• Market composed of different segments
• Entrant targets one specific segment
• Leads to more differentiated products
• All prices may rise
• Consumers left behind not targeted by the entrant.
• Welfare Analysis is not obvious

Slide 9

Issue 2: Segmentation and Competition Raising Prices

• Theory: Chen and Riordan
• Economics working paper CU Boulder
• Case Study 1 DBS versus Cable
• Goolsbee and Petrin working paper version 2001
• Case Study 2 Broadband
• Chen and Savage Working paper CU Boulder 2007
• Case Study 3 Price Flexibility in California
• Prices rises for basic services

Slide 10

Issue 3: Barriers to Entry

• Interconnection
• Agreements may be difficult
• Delays entry and costly litigation raise rivals costs
• Exclusive Provider Agreements
• Master Planned Communities
• FCC focused on Video but also applies to Telecom
• Can exclude entry but speed deployment
• Special Access Issues
• Essential Input for telecom entrants
• Incentive to raise rivals costs
• FCC capped SBC VZ prices in 2005 mergers
• Cap expires fear of price hikes and discrimination

Slide 11

Issue 4: Wireless entry

• Limited wireless competitor for wireline access & broadband (Leap Metro PCS)
• Long history of wireless entrant failure and exit
• AWS auction; No significant new entry
• 700 MHz auction: best opportunity for entry
• Spectrum caps worked in 1994
• Auction with no caps = Incumbent merging with entrants with no DoJ review
• Caps in auction but not holdings
• Transfers would lead to DoJ & FCC merger review

Slide 12

Summary

• Market is evolving
• New products, technology, and strategies
• More economic analysis is required
• Both naïve regulation and deregulation without analysis may harm consumers