Unbundling the incumbent: Evidence from UK broadband

M. Nardotto (ParisTech), T. Valletti (Imperial and ParisTech) and F. Verboven (KU Leuven)

Introduction

• Policies aimed at “opening” the incumbent have been often applied:– Electricity market– Transportation– OUR CASE: Telecommunications (all over EU, and

elsewhere – not US though)• Motivation: higher competition downstream should

lead to lower prices, higher quality and more demand• Few empirical studies answering the question: DOES

IT WORK?

This paper

• We study the broadband market in UK, where:• BT owns the network (Local Exchanges)• Two possible entry strategies (downstream):– Bitstream: low investment, BT still provides most of

the service (reduced area of responsibility of entrant)– Local-Loop Unbundling (LLU): bigger investment by

entrants.• Another competitor is cable (NTL:Telewest, now

Virgin) with a competing “closed” network

This paper – findings

• MAIN QUESTION: Did entry through LLU induce market expansion?

• RESULT: penetration is not improved by LLU• Then, we show:

1. Incentives for LLU change the composition of entrants’ technological portfolio

2. Inter-Platform competition leads to more penetration (BT lines v.s. cable)

Related literature• Theory papers (surveys of Armstrong, Laffont and Tirole)• Very rich policy (and advocacy) debate. Very few empirical works,

almost no micro-data.• Grajek and Roller (2011, JLawEc): Regulation negatively affects

total investments in facilities. Panel of EU countries, aggregate data.• Sraer (2008): WP on LLU and penetration (French data), Fevrier,

Gaubert and Sraer (2011): structural model (cross-section)• Minamihashi (2011): effect of regulation of both LLU and fiber in

Japan. Regulation made more difficult to invest in fibre. • Studies on entry in US using earlier data: Greenstein and Mazzeo

(2006, JIndEc), Economides, Seim and Viard (2008, RAND), Xiao and Orazem (2011, IJIO), Goldfarb and Xiao (forthcoming, AER)

Broadband market

• Broadband in UK is provided by:– Fixed line telephone operators– Cable operator

• British Telecom group (BT retail/BT wholesale/ Openreach) is the incumbent of the fixed line telephone network

• Virgin Media is the only cable operator (network built in the 80’s)

• BT’s network has a (fiber) backbone and serve consumers locally through delivery points (local exchanges, LEs) which cover the “last mile”

Broadband market

• Each household is connected to a specific LE in the grid

Broadband market

• Late 90’s: BT opened the “last mile” to entrants

• Regulation by Ofcom:1. BT had to upgrade the network to allow for entry (completed in

2002-03)2. Regulated wholesale prices that entrants have to pay to BT

• Entry options:– (Simple re-selling)– Bitstream: low investment by the entrant in the LE, the

connection is still managed by BT– LLU: higher investment by the entrant. Entrants install DSLAM

equipment, routers, cabinets, provide maintainance, etc

Local Exchanges (LEs)

• Called “Central Offices” in the US

• 5,587 LEs in the UK grid• Becoming LLU supplier costs

approx £100k per LE (one-off), plus ongoing costs

Regulation and goals

• Regulator’s perspective (Ofcom WBA rev. 2006):

“The importance of broadband continues to grow. It plays a central role in communications used by many consumers and businesses to keep in touch, access information and conduct business.”

“Competition has an important role to play in delivering what consumers and businesses need”

“Competition at the retail level depends on ISPs having access to wholesale broadband services or local loop unbundling (LLU) to build their services. Ofcom has identified that competition between networks based on LLU, rather than just at the retail level based on wholesale broadband products, is crucial to maintaining the UK's broadband progress.”

Data

• Quarterly panel data on investments and subscriptions in the period 2005 (Dec) – 2010 (Jan) at the LE level (5,587). In each LE we observe:– Postcode and geographical coordinates– Total number of potential lines (households)– Number of lines potentially served by cable– Lines actually served by cable– Lines served by entrants through LLU (disaggregated by

operator)– Total lines served by bit-stream– Total lines with broadband (LLU + cable + bit-stream)

Penetration over time

• Penetrationincreases significantlyover our timespan

Relative shares of the technologies

• Over time therelative shareof BT retail is stable

• Entrants substitute bit-stream withLLU

LLU expansion

• In few years the adoption of LLU becomes more widespread:

Whole BT grid of LEs + cable

LLU and Entry - 1

• The 677 LEs where we observe LLU are different:

Variable Obs Mean Std. Dev.Wilcoxon – Pr

Test(p-value)

Period

Size 4840 3420 5131

<0.000

1

Size 677 16082 9984 1

Urban 4840 0.28 0.44

<0.000

1

Urban 677 0.85 0.36 1

LLU and Entry – 2• And the difference is still there in period 17

(entry tripled to 1,985 LEs)

Variable Obs Mean Std. Dev.Wilcoxon –

Pr Test(p-value)

Period

Size 3532 1230 1251<0.000

17

Size 1985 11961 8560 17

Urban 3532 0.12 0.32<0.000

17

Urban 1985 0.76 0.43 17

LLU and Entry - 3

• Entrants make LLU investment where the market is profitable, i.e.– It is larger in size– Income is higher– Maintainance can be done more efficiently

• Hence, it is crucial for identification, to control for unobserved heterogeneity in the local LE markets

LLU and Entry - 4

• We estimate the following model:

• Where the regressors are:– Size of the LE (number of lines)– Dummy variable for urban areas

)()|1Pr( , xxLLU ti

LLU and Entry - 5Probit regression Number of obs = 5517 LR chi2(2) = 1436.60 Prob > chi2 = 0.0000Log likelihood = -1335.6417 Pseudo R2 = 0.3497

------------------------------------------------------------------------------LLU cov. | dy/dx Std. Err. z P>|z| [ 95% C.I. ] X---------+-------------------------------------------------------------------- Size | .0110998 .00066 16.84 0.000 .009808 .012392 4.97406 Urban | .0762649 .01026 7.43 0.000 .056147 .096383 .349828------------------------------------------------------------------------------

• The average size in the sample is 5,000 lines. At this size very few are activated.

• The difference in the activation prob. between a 5,000 lines LE and a 15,000 lines LE is 11%

• The difference in the activation prob. between a LE in a urban area and LE in a non urban area is 7.6%

Does LLU increase penetration?

• We estimate a panel regression for the penetration:

• We use the F.E. estimator• Two LLU entrants particularly important in the data,

Sky (TV) and CPW (who in the period bought AOL, Tiscali, Talk Talk)

• Account also for some spatial (neighbourhood) effect• Additional regressor is the time since LLU is activated

titttitititi CableLLUPen ,1732,2,10, ..

Panel FE estimation

LLU vs. Bit-Stream

• Do firm change their technology?

titttitititi CableLLUADSL ,1732,2,10, ..

LLU vs. Bit-Stream

Possible explanations

• Firms may not engage in price competition.• How to test it? Bresnahan – Reiss approach:

look at the market size needed to sustain an extra-entrant:

– If there is competition then ETR should be greater than 1 and increasing

)1/()1(

/)()(

NNS

NNSNETR

Possible explanations

• Estimated thesholds:

Possible explanations

• Lack of competition• Product differentiation?• Heterogenous entrants?• “Ladder of investment” does not seem to work• Locus of competition is not price, rather quality

Next steps/Ongoing work

• We are collecting demographics at the LE level (complicated but feasible)

• Penetration may not be the only objective, in particular we are collecting data on:– Speed of the connection– Reliability of the service

• We are also looking at the entry strategies (product differentiation)

• Also, recomputing entry plus exit threshold ratios with simple entry dynamic model