network industry with monopoly infrastructure · 2003-12-17 · network industry with monopoly...

Network industry

with monopoly infrastructure

Welfare consideration of alternative vertical structure

Alain BOURDEAU de FONTENAYPresentation to

The Future of Telecommunications Sector Investment,

A CITI Conference, Columbia University

New York, 4 March, 2002

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Outline

• Background• Objective• Parameters• Determinants• Closing question

I would like to thank Bruno Chaves, Paris I/Sorbonne, who bears no responsibility for any of the errors but who has helped me enormously through his unique insights,...

Background

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Lipsky & Sidak’s 1999 “Essential Facilities”

Baxter:– “Settled the AT&T case by splitting up the

Bell System.” based on

– Remedies having to be “both”:• “Feasible for a court to administer”; and• “Conducive to enhancing consumer welfare.”

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Crandall’s 1999 “Managed Competition in US Telecommunications”

• “One obvious choice for liberalizing a network industry with natural-monopoly infrastructure is simply to separate the infrastructure from the delivery of the service”;

• “The natural monopoly in telecommunications -- if there is one”:– “Is in the local distribution of messages to the

subscriber”; and– “Could be divorced from the... regional

distribution function”

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Crandall’s 1999 - II/IV

• “The vertical separation of facilities from... services may be a satisfactory second-best solution... in industries... [with] little... technological change, such as railroads or pipelines. ”; and

• “In technologically progressive industries, such as telecommunications, such separation creates enormous problems of modifying and expanding the infrastructure...”

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Crandall’s 1999 - III/IV

• “Vertical separation”:– Baxter’s solution:

• Feasible; and• To enhance social welfare;

– Crandall: • Effectively “a satisfactory second-best solution.”

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Crandall’s 1999 - IV/IV

In telecommunications– In the case of the 1984 AT&T divestiture, “despite all

of these changes, there have been few problems in accommodating the essential traffic-exchange function that is required for competition in this network industry.”

– At the same time, he argues such separation:• Creates... problems; but• What are the alternatives?• Is it not an implementation problem?

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Is it conducive to enhancing consumer welfare?

• Is it social welfare-enhancing?– Baxter’s second requirement.– In Pennsylvania:

• The PUC was informed by Verizon that full structural separation would cost approximately $1 Billion; and

• No evidence was given for the amount.

• Crandalls reservation is set aside:– Important; but– A matter of implementation.

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Objective

We agree with Verizon that it is not possible at this stage

to “know with certainty the full impact of such a corporate reorganization.”

This does not diminish the value of developing a “best guess” of its cost and benefit to the

stakeholders.

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Conclusions

Vertical separation would appear to benefit, a priori (and depending upon how well it is

implemented) not only society but probably the ILECs due to factors such as:

• Improved valuation of the ILEC on the capital market, hence improved access to capital;

• Economies of scale and, probably, economies of scope; and

• Probably, transaction and organization costs.

Parameters

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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What kinds of cost/benefit?

• What cost/benefit?– Transitory: ILEC reorganization; or– Net present value: Gains/losses due to the new structure?

• What benchmark for comparison?– Is it the status quo?– How is it “quantified”?...

• Whose cost/benefit?– The ILEC’s Network? – Its shareholders?– Social?

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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What kind of model?

• An ILEC’s “commercial” wholesale unit (e.g., Telstra):– Probably short run incremental solution;– No problem, mostly:

• Low costs; and• High profits.

• Vertical separation:– The question considered here.

Determinants

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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What determinants?

• The ILECs’ market valuation;

• Economies of scale and scope;

• Investment plans and production costs; &

• Transaction and organization costs.

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Valuing market structures

• Vertical separation would contribute to a better valuation of the ILEC:– Improved:

• Capital market efficiency; and• Strategic planning.

– In 2001 in the UK,• Earthlease and Compere/WestLB express interest in

BT’s infrastructure assets;• Many analysts and some BT shareholders viewed that as

win-win;

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Economies of scale and scope

Interconnection and unbundling “essentially confers on [the ILEC’s] competitors whatever economies of

scale and scope [it] possesses.”(Teece, 1995)

The converse is also true and what matters are the economies of scale and scope of the interconnected and unbundled networks.

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Economies of scale

• Vertical separation and scale:– Network benefits:

• Increased demand; and• More stable demand.• Question: How is local access wholesale priced?

– Retail benefits if it is competitive and able to diversify and compete;

– Shareholders unless the ILECs can extract sufficient rents from information asymmetries (e.g., ASI);

– Social welfare

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Separability & economies of scope

• Separability: Evaluated through scope between wholesale and retail products;

• Vertical separation and scope:– Harder to determine ex ante;– However, if the boundary is related to organization

boundaries, it would not create additional costs;– Best guess: unlikely to be a significant factor (barring high

external transaction costs).

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Transaction and organization costs I/III

• Moving from a larger to 2 smaller management structures is typically an unknown:– Potentially, more managers; but– Potentially, a leaner more flexible and

responsive organization.

• Moving from one to 2 profit centers:– Improved resource allocation, strategic planning,

and wholesale pricing; and– Better market information.

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Transaction and organization costs II/III

OSS/BSS• Unlikely to be a significant factor:

– Very large economies of scale;– Increasingly modular and scalable; and

– Relatively short live span.

• Potentially, a positive factor:– Incentive to design OSS/BSS for:

• Efficiency and QOS rather than• Increasing competitors’

transaction costs.

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Transaction and organization costs III/III

• Is it introducing a new layer (hence, a new source of costs)?– No: look at Telstra’s TIC. Organizations need

essentially the same information as markets for efficient budget planning:

• How much to produce?• Of what?• What will it cost?

“ W h o l e s a l i n g T e l e c o m A c c e s s ”

C I T I , C o l u m b i a U n i v e r s i t y ,

N e w Y o r k , N Y - 2 0 0 2 / 0 3 / 0 4

“ A l t e r n a t i v e v e r t i c a l s t r u c t u r e ”

A l a i n B O U R D E A U d e F O N T E N A Y , Ph . D .

A. d e F o n t e n a y @i e e e. o r g

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Closing questionWhile the answer to Baxter’s question cannot be answered unambiguously without knowing how vertical separation might

be implemented,... the “best guess” principle does suggest that today’s vertical integration might not maximize

shareholders’ value.

Why then such opposition to it? Crandall suggests:

– Existing cross subsidies (“Incumbents naturally respond very aggressively to

the loss of market share...”);

– [essential facilities] (“Since these incumbents are typically vertically

integrated, providing all telecommunications services, their local network connections are essential for originating and terminating the new rivals' calls.”)