Summary of Phoenix Center 2006 Research

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Summary of Phoenix Center 2006 Research Dr.
George Ford Chief Economist 2006 Annual U.S.
Telecoms Symposium Grand Hyatt Conference
Center Washington DC December 6, 2006
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2006 ResearchPolicy Papers
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2006 ResearchPolicy Bulletins
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2006 Research Major Telecom Issues
Cable Competition/Franchise Reform
Network Neutrality
Universal Service Reform
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Phoenix Center Policy Bulletin No. 14 In
Delay There Is No Plenty The Consumer Welfare
Cost of Franchise Reform Delay
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POLICY BULLETIN NO. 16 Cost of Franchise Reform
Delay

• Competition in Video Markets reduces prices,
  thereby benefiting consumers
• Prices reductions 10 to 40.
• Franchise process deters competition, thereby a
  failure to reform it creates consumer welfare
  losses.
• How big are the consumer surplus losses?

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POLICY BULLETIN NO. 16 Cost of Franchise Reform
Delay
Consumer Surplus
Gain to Consumers From Competition
Time
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POLICY BULLETIN NO. 16 Cost of Franchise Reform
Delay
Consumer Surplus
DCS
Loss to Consumers From Delay
Time
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POLICY BULLETIN NO. 16 Cost of Franchise Reform
Delay
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Phoenix Center Policy Paper No. 24 Network
Neutrality and Industry Structure
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POLICY PAPER NO. 24 Network Neutrality and
Industry Structure

• Our arguments derives from a well-understood
  principle of industrial economics
• as the products of firms become more alike, price
  competition intensifies. In the presence of sunk
  costs, intense price competition renders more
  highly concentrated markets. In terrestrial
  telecommunications, the industry is already
  highly concentrated (duopoly?), so increasing
  concentration could mean monopoly.

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POLICY PAPER NO. 24 Network Neutrality and
Industry Structure

• Moving toward the other firm increases the
  intensity of price competition. J. Tirole, The
  Theory of Industrial Organization 1995
• We see that with homogeneous products price
  equals marginal costs (the competitive result),
  while if products are completely differentiated
  price is set at the monopoly level. S. Martin,
  Advanced Industrial Economics 1993
• Where the product or service is perceived as a
  commodity or near commodity, choice by the buyer
  is largely based on price and service, and
  pressures for intense price and service
  competition results. These forms of competition
  are particularly volatile . Product
  differentiation, on the other hand, creates
  layers of insulation against competitive warfare
  because buyers have preferences and loyalties to
  particular sellers. M. E. Porter, Competitive
  Strategy 1980

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Equilibrium Industry Structure(Policy Papers No.
10 and 21)
N Equilibrium Number of Firms S Market Size
() f Index of Weakness of Price Competition
() E Sunk Entry Costs (-)
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POLICY PAPER NO. 24 Network Neutrality and
Industry Structure

• Policymakers should balance concerns over
  potential discrimination against the possibility
  that particular network neutrality rules may
  encourage very aggressive price competition that
  is incompatible with multiple firm supply in the
  face of significant sunk costs and scale
  economies.

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Phoenix Center Policy Paper No. 25 The Burden
of Network Neutrality Mandates on Rural Broadband
Deployment
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POLICY PAPER NO. 25 Network Neutrality and Rural
America

• If a regulation reduces profits, and binding
  regulation always impacts profits, there will be
  and lower profits mean less network deployment.
  The question is whether urban and rural areas are
  differentially affected by a profit-affecting
  regulation (such as network neutrality).

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POLICY PAPER NO. 25 Network Deployment
C Network cost to serve a household V Net
Value of customer h homes passed by the
network h is homes passed by the network
given C and V.

C
V
h
100
0
Homes Passed (h), Ranked by Cost
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POLICY PAPER NO. 25 Network Deployment with
Higher Cost
CR Network cost to serve a household under
Regulation V Net Value of customer hR homes
passed by the network under
Regulation

CR
C
V
h
100
0
hR
Homes Passed (h), Ranked by Cost
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POLICY PAPER NO. 25 Network Deployment,
Different Markets


Cost Curve is Relatively Steep
Cost Curve Is Relatively Flat
C
C
V
V
h
100
0
h
100
0
Homes Passed (h), Ranked by Cost
Homes Passed (h), Ranked by Cost
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POLICY PAPER NO. 25 Measured Impact of Regulation
Our simulation shows that, on average, high-cost
(more rural) markets experience larger reductions
in network deployment than do low-cost (more
urban) markets.
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POLICY PAPER NO. 25 Network Neutrality and Rural
America
Relatively Flat Slope
V
Relatively Steep Slope
V
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POLICY PAPER NO. 25 Network Neutrality and
Broadband Deployment to Rural America

• Network neutrality rules that reduce the
  profitability of deploying network -- and binding
  regulation always reduces profit -- will reduce
  network deployment generally. But, this reduced
  deployment may be felt to a larger extent in
  high-cost, more rural markets.

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Policy Bulletin No. 16 The Efficiency Risk of
Network Neutrality Rules
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POLICY BULLETIN NO. 16 Efficiency Risk of
Network Neutrality
General Cost-Benefit Framework for
evaluating regulated network architectures
Analysis of the incentive to invest in
cost-reducing technologies
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POLICY BULLETIN NO. 16 Cost Benefit Framework
Ri Consumer Gross Value of Network Type i
Pi Price Paid for Service of Network Type i
Vi Ri Pi Net Consumer Value of Network Type
i
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POLICY BULLETIN NO. 16 Cost Benefit Framework
Stupid Network S Intelligent Network
I
Stupid network preferred if VS gt VI
RS PS gt RI PI
M Markup over cost C Cost
RS MSCS gt RI MICI
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POLICY BULLETIN NO. 16 Cost Benefit Framework
RS MSCS gt RI MICI
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POLICY BULLETIN NO. 16 Cost Benefit Framework
RS MSCS gt RI MICI
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POLICY BULLETIN NO. 16 Cost Benefit Framework
RS MSCS gt RI MICI
Whats it worth and what does it cost?
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POLICY BULLETIN NO. 16 Investment in
Cost-Reducing Technology

• Scenario
• Cost reducing technology is available to a
  monopoly
• But, the technology reduces the value of the
  service to consumers
• Under what conditions will the firm make the
  investment?
• The investments made if it is profitable to the
  firm
• The investment is made only when consumer surplus
  rises (i.e., the lower price more than offsets
  the lower marginal valuation)

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POLICY BULLETIN NO. 16 Investment in
Cost-Reducing Technology

• Voluntary investments by network firms in
  cost-reducing technology are welfare improving
  even if the technology reduces the marginal value
  of the services produced by the technology.
• Even a monopolist will make the right decision
  for consumers.

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Phoenix Center Breakfast Meeting NARUC, Miami,
November 2006 Primer on Competitive
Biddingfor Universal Service
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Goals of Universal Service
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Why Have Universal Service?
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How do we subsidize?Carefully
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How do we subsidize?Uncarefully

Same Subsidy, Different Result. Subsidized
action must be very specific and observable.
Capital Cost to Serve
Homes Passed
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How do we subsidize?Uncarefully

Even if we only pay for new lines, we can run
into problems.
Capital Cost to Serve
Homes Passed
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Competitive Bidding and Franchise Bidding
Competitive bidding is akin to a franchise
bidding scheme, where franchise bidding is a
competition among firms for the exclusive right
to serve.
The right to offer service in a market is
auctioned off to the firm willing to offer
fixed level of service at the lowest price.
With scale economies, franchise bidding
theoretically renders a better outcome than
multi-firm competition. We get the competitive
outcome with the monopoly cost structure.
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Competitive Bidding with Subsidy
Competitive Bidding is different when a subsidy
is involved.
The bid price (average cost) is above the
affordable or target price. Thus, a subsidy is
required.
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Competitive Bidding with Subsidy Example
Lowest Avg Cost of Service AC 50
Target Price is PT 20
Lowest Subsidy Bid is S 30
PT - AC S 0
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Competitive Bidding with Subsidy Example
Lowest Avg Cost of Service AC 50
Target Price is PT 20
Firm sells other stuff for margin M 10
Lowest Subsidy Bid is S 20
PT M - AC S 0
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Franchise BiddingWith Subsidy
PT Target or Affordable Price
Total Subsidy
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Subsidy BiddingTwo Firms
With two equally-sized firms, the market is
split. The bid, equal to ACQ/2, reflects the
split. The subsidy grows substantially even if
both firms are equally- and most efficient.
Total Subsidy Two Firms
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Benefits of Competition
Competition increases social welfare by reducing
the dead weight loss of monopoly. As prices
fall, consumer surplus rises faster than profits
decline.
Transfer of Profit to Consumer Surplus
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Cost of Subsidies
Gathering funds for subsidy creates distortions
in other markets, leading to efficiency losses.
Transfer of Consumer Surplus to Government
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Lets make soup
What are the relationships of interest?
PT M AC S 0
DS/DPT lt 0
DS/DMlt 0
DS/DAC gt 0
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Lets make soup
Consider a case where we use bidding and allow
multiple winners (Ngt1). What happens relative to
an exclusive winner?
PT M AC S 0
Competition in subsidized markets increases the
amount of subsidy both through margin declines
and cost increases.
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Whats competition worth?
To consider what competition is worth, lets
assume AC is constant (not rising with the number
of firms).
Subsidy rises, harming consumers.
PT M AC S 0
Margins fall, benefiting consumers.
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Competition and Subsidies
Taxed Market
Subsidized Market
1
1
This is not the usual transfer from firms to
consumers as a result of competition, it is a
transfer from consumers in one market to
consumers (and producers) in another.
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Competition and Subsidies
Taxed Market
Subsidized Market
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Whats competition worth?
If we need 1 of subsidy due to a 1 margin
decline, then we need 1 of subsidy collection.
Thus, there are distortions created (higher
taxes) for the distortions eliminated (lower
margins). Rough estimates suggests a 1 price
decline in the subsidized market generates 0.05
of additional surplus, but costs 0.65 of surplus
in collection on average. At the margin,
collection costs are 1.25 per 1 of subsidy.
With franchised bidding, competition in
subsidized markets is likely welfare reducing,
even if we ignore the undesirable cost impacts of
competition. 1 competitive benefit costs 1.60.
J. Hausman, Taxation by Telecommunications
Regulation, NBER Working Paper W6260 (1997).
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Whats competition worth?
If we need 1 of subsidy due to a 1 margin
decline, then we need 1 of subsidy collection.
Thus, there are distortions created (higher
taxes) for the distortions eliminated (lower
margins). Rough estimates suggests a 1 price
decline in the subsidized market generates 0.05
of additional surplus, but costs 0.65 of surplus
in collection on average. At the margin,
collection costs are 1.25 per 1 of subsidy.
The subsidy payout scheme should be determined
jointly with the subsidy collection scheme (or at
least considered).
J. Hausman, Taxation by Telecommunications
Regulation, NBER Working Paper W6260 (1997).
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Whats competition worth?
In fact, AC will rise, indicating competition is
likely a net loser in social welfare terms.
PT M AC S 0
Competition further lowers social welfare by
raising costs and, thus, increasing subsidies.
Just like with competition, 1 in higher costs
requires 1.60 in welfare to collect.
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Conclusion
Competitive bidding schemes that allow
competition in the subsidized markets are likely
welfare reducing and should be avoided.
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Some Caveats
Ive assumed that competitive bidding renders a
zero profit equilibrium, like it should in theory
(but may not in practice).
Ive assumed competition only affects prices.
Administrative costs are ignored.
Strategic bidding is absent.
Ive assumed any subsidy cap is not binding.
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2006 Annual U.S. Telecoms Symposium Grand Hyatt
Conference Center Washington DC December 6, 2006