TCOM 546
Session 1
Course Objective
• Provide a broad overview of economic and financial analysis of telecommunications systems– Microeconomic analysis– Financial and accounting methods– Telecommunications cost models
• Limited math involved – Minimize use of calculus
Course Texts
• The Economics of Network Industries, Oz Shy, Cambridge University Press, ISBN 0 0521 80500 7
• Financial Modeling, Simon Benninga, MIT Press, ISBN 0 262 02437 3
• Supplemental readings
Evaluation and Grading
• Homework 25%
• Term paper/project 25%
• Final exam 25%
• Class participation (quizzes) 25%
Homework
• Collaboration is permitted (encouraged) on homework and papers/projects
• But all graded work must be the original effort of the student submitting the material
• This means:– Two or more students can develop a solution
approach for a homework problem together, – But each student must independently execute the
solution
• Collaboration in tests or exams is not permitted
Sources
• Students are encouraged to use all available sources to answer a question or for a paper/project– All sources must be attributed and material
reproduced directly must be enclosed in quotation marks
• Students are expected to have a personal computer and Internet access
Course Overview
• The subject matter will start at a general level (economic theory) and converge to more specific considerations over the semester
• Approximately the first third of the course will consider microeconomic theory – text for this is Shy: Economics of Network Industries
Course Overview (Continued)
• Middle part of class will deal with classical financial models – balance sheets, etc., with some spreadsheet examples – Text is Benninga
• Final part will deal with cost modeling from a user’s viewpoint – including a case study
Course Overview (Continued)
• Week 1: Introduction – Overview of the economics network industries, including welfare aspects and issues specific to telecommunications industries
• Week 2: Introductory example: Hardware – computers and compatibility
• Week 3: Telecommunications microeconomics– monopolies, new entrants and social welfare
Course Overview (Continued)
• Week 4: Telecommunications microeconomics continued – more detailed analyses
• Week 5: Broadcasting and information industries microeconomics
• Week 6: Introduction to financial statement modeling
Course Overview (Continued)
• Week 7: Financial statement modeling continued
• Week 8: Valuation using financial statement models
• Week 9: Financial analysis of leasing
• Week 10: Cost models of telecom from the buyer’s perspective
Course Overview (Concluded)
• Week 11: An example of cost modeling for a large telecommunications procurement
• Week 12: Course review and recap
• Week 13: Student presentations
• Week 14: Final Exam
Paper/Project Topics
• Students are expected to develop class paper/project topics themselves– Choice of topic subject to approval – If you can’t/don’t want to develop a topic, I will
provide one for you• You may not like it
Quizzes
• Quizzes will be given in class about every two weeks – They will last approximately half an hour
• They will address only material covered to date in class
Level Setting
• Experience with– Calculus?– Game theory?
A Question
• What is the single most important factor in determining the social utility of a telecom network?
A Question
• What is the single most important factor in determining the social utility of a telecom network?
• The number of connections it has
Distinctive Characteristics of Network Markets
• Externalities
• Systems/Complementarity
• Costs of change (lock-in)
• Economies of scale
• Barriers to entry
Externalities
• Multiple equilibria possible
• Initially few adopters
• Achievement of critical mass followed by rapid growth– Sigmoid (logistic) curve y = 1/(1+exp(-x))
• Eventual near-complete market saturation
Two Equilibria
Number of Adopters
MarginalUtility or Cost
Utility
Cost
“Nobody”uses
“Everybody”uses
Complementarity
• Elements of system must interoperate successfully
• Requires employment of standards
Costs of Change
• Contracts (commitment)
• Operational familiarity
• Acquisition cost
• Transition cost– Resources committment– Dual operation– CPE changes
Economies of Scale
• Big networks are more cost effective than small ones– Traffic engineering/Erlang
• High fixed costs, low variable costs
• No stable multi-provider equilibria
Barriers to Entry
• Difficult to unseat an incumbent
• Specific (and critical) example: Last mile wiring
Natural Monopolies
• Characteristics of telecom systems class them as natural monopolies
• Natural monopolies tend towards higher prices and lower social welfare than optimal– Violate First Welfare Theorem, which states
that equilibrium allocation in a free market is economically efficient
– Existence of externalities also invalidates the First Welfare Theorem
Historical Approach
• Historical approach to optimizing social welfare under a natural monopoly has been government regulation of a monopoly provider– Limit ability of provider to exceed a “fair” price– Avoid costly duplication of resources (e.g.,
access wiring) by multiple providers
Problems with Regulatory Approach
• Provider unresponsive to customer needs and preferences– E.g., slow introduction of new technology
• Failure to control prices– Asymmetric information– Inflated production costs
Current Approach
• Attempt to introduce competition– First notable success was U.S. airline
deregulation in 1979– In telecommunications, mixed success
• 1984 break-up of the Bell System was quite successful in inducing inter-LATA communications competition
• 1996 Telecommunications Reform Act has so far been spectacularly unsuccessful in inducing intra-LATA communications competition
Year
Relative
Cost
0%
20%
40%
60%
80%
100%
120%
140%
1983 1987 1991 1995 1999
Commercial Business Line
Commercial Long Distance
Source: Bureau of Labor Statistics
Telecom Price History
Homework
• Read Shy, Chapters 1 and 2
• We showed graphically how there could be two equilibria in a market. Produce a graphical example with three or more equilibria. Does this example have any reality?