1
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
2
2006 Research
Policy Papers
3
2006 Research
Policy Bulletins
2006 Research
Major Telecom Issues
Cable Competition/Franchise Reform
Network Neutrality
Universal Service Reform
4
5
Phoenix Center Policy Bulletin
No. 14
“In Delay There Is No Plenty”: The
Consumer Welfare Cost of
Franchise Reform Delay
6
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?
POLICY BULLETIN NO. 16
Cost of Franchise Reform Delay
$
Consumer
Surplus
DCS
DCS
Gain to
Consumers
From Competition
Delay
Time
7
POLICY BULLETIN NO. 16
Cost of Franchise Reform Delay
$
Consumer
Surplus
DCS
DCS
Loss to
Consumers
From Delay
Time
8
9
POLICY BULLETIN NO. 16
Cost of Franchise Reform Delay
Consumer Welfare Effects from Delay
Years
Delay
Con. Surplus
No Delay
Con. Surplus
With Delay
Lost
Surplus
1
$93.2B
$85.0B
$8.2B
2
$93.2B
$77.3B
$15.9B
3
$93.2B
$70.1B
$23.1B
4
$93.2B
$63.3B
$29.9B
5
$93.2B
$56.9B
$36.3B
10
Phoenix Center Policy Paper
No. 24
Network Neutrality and Industry
Structure
11
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.
12
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]
13
Equilibrium Industry Structure
(Policy Papers No. 10 and 21)
S
N* 
E
N* = Equilibrium Number of Firms
S = Market Size (+)
 = Index of Weakness of Price Competition (+)
E = Sunk Entry Costs (-)
14
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.
15
Phoenix Center Policy Paper
No. 25
The Burden of Network Neutrality
Mandates on Rural Broadband
Deployment
16
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 profitaffecting regulation (such as network neutrality).
17
POLICY PAPER NO. 25
Network Deployment
C = Network cost to serve
$
a household
Subsidy Required for
100% Homes Passed
V = Net Value of customer
C
h = homes passed by the network
V
0
h* is homes passed by the network
given C and V.
h*
100%
Homes Passed (h), Ranked by Cost
18
POLICY PAPER NO. 25
Network Deployment with Higher Cost
CR = Network cost to serve
$
Subsidy Required for
100% Homes Passed
CR
a household under Regulation
V = Net Value of customer
C
hR = homes passed by the network
under Regulation
V
0
hR
h*
100%
Homes Passed (h), Ranked by Cost
19
POLICY PAPER NO. 25
Network Deployment, Different Markets
$
Cost Curve
Is Relatively Flat
CR
$
Cost Curve
is Relatively Steep
C
C
V
V
0
CR
hR
h*
100%
Homes Passed (h), Ranked by Cost
0
hR
h*
100%
Homes Passed (h), Ranked by Cost
20
POLICY PAPER NO. 25
Measured Impact of Regulation
2.4
1.9
1.4
0.9
0.4
Reduction in Homes Passed,  h
Figure 5. Network Neutrality and Service Reduction
Cost Index, u
Our simulation shows that, on average, high-cost (more rural)
markets experience larger reductions in network deployment
than do low-cost (more urban) markets.
21
POLICY PAPER NO. 25
Network Neutrality and Rural America
Reduction in Homes Passed, D h
Figure 5. Network Neutrality and Service Reduction
United-VA
u
$3.00
$2.80
$2.60
Relatively Flat Slope
$2.40
$2.20
$2.00
$1.80
$1.60
V
$1.40
$1.20
$1.00
2.4
1.9
1.4
0.9
0.4
h
Cost Index, ū
United-MO
u
$3.00
SBC-TX
$2.80
u
Very Steep Slope
$2.80
$2.60
SBC-TX
$2.20
$2.00
$1.60
$2.40
United-MO
$2.20
$2.40
$1.80
Relatively Steep Slope
$2.60
$3.00
$2.00
$1.80
$1.60
V
V
$1.40
$1.20
$1.40
$1.00
$1.20
h
$1.00
h
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.
22
23
Policy Bulletin No. 16
The Efficiency Risk of Network
Neutrality Rules
24
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
25
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
26
POLICY BULLETIN NO. 16
Cost Benefit Framework
Stupid Network = S
Intelligent Network = I
Stupid network preferred if:
VS > VI
RS – PS > RI – PI
M = Markup over cost; C = Cost
RS – MS·CS > RI – MI·CI
27
POLICY BULLETIN NO. 16
Cost Benefit Framework
RS – MS·CS > RI – MI·CI
Is one architecture more desirable
to consumers than another,
and by how much?
28
POLICY BULLETIN NO. 16
Cost Benefit Framework
RS – MS·CS > RI – MI·CI
Does architecture affect
Industry structure and thus margins,
and by how much?
29
POLICY BULLETIN NO. 16
Cost Benefit Framework
RS – MS·CS > RI – MI·CI
Is one network more
costly than another,
and by how much?
What’s it worth and what does it cost?
30
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)
31
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.
32
Phoenix Center Breakfast
Meeting: NARUC, Miami,
November 2006
Primer on Competitive Bidding
for Universal Service
33
Goals of Universal Service
To provide subsidies so that access
at an affordable price is provided
in areas where access would not
be provided at an affordable price
without the subsidies
To accomplish this task at the
minimum economic cost of
providing the relevant set of
access services.
34
Why Have Universal Service?
$
Losses
R
Profits
h
R = Net Revenue
Homes Passed
How do we subsidize?
Carefully
35
$
Subsidy
R
h
R = Net Revenue
Homes Passed
100%
How do we subsidize?
Uncarefully
$
Same Subsidy,
Different Result.
Subsidized action
must be very specific
and observable.
P+S
P
h
hS
Homes Passed
36
How do we subsidize?
Uncarefully
$
Even if we only pay
for “new” lines, we
can run into
problems.
P+S
P
h
Homes Passed
hS
37
38
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 multifirm competition. We get the competitive outcome
with the monopoly cost structure.
39
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.
40
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
41
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
42
Franchise Bidding:
With Subsidy
$
PT = Target or Affordable Price
Per-Line ACT
Subsidy
PT
AC
Total Subsidy
QT
Quantity
43
Subsidy Bidding:
Two 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.
ACQ/2
SQ/2
S
ACT
Total Subsidy
Two Firms
AC
PT
Q/2
QT
Quantity
44
Benefits of Competition
$
PM
PC
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
Reduction in
Dead Weight Loss
Demand
QM
QC
Quantity
45
Cost of Subsidies
$
PS
P
Gathering funds for subsidy
creates distortions in other
markets, leading to efficiency
losses.
Creation of
Dead Weight Loss
Transfer of
Consumer Surplus
to Government
Loss of Producer Surplus
Demand
MC
QS
Q
Quantity
46
Let’s make soup
What are the relationships of interest?
PT + M – AC + S = 0
DS/DPT < 0
DS/DM< 0
DS/DAC > 0
DS/DN > 0
Competition increases the subsidy!
Let N be the number of
entrants:
DM/DN < 0
DAC/DN > 0
47
Let’s make soup
Consider a case where we use bidding
and allow multiple winners (N>1). 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.
48
What’s competition worth?
To consider what competition is worth,
let’s assume AC is constant (not rising
with the number of firms).
Subsidy rises,
harming
consumers.
PT + M – AC + S = 0
Margins fall,
benefiting
consumers.
49
Competition and Subsidies
$
Subsidized Market
$
“Taxed” Market
These cancel
Gain to
Consumers
PM
Loss to
Consumers
PS
Loss to
Firms
$1
$1
P
PC
D
D
QM
QC
Quantity
QS
Q
MC
Quantity
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.
50
Competition and Subsidies
$
Subsidized Market
$
“Taxed” Market
What are the
relative sizes of
these things?
PM
PS
PC
P
D
D
QM
QC
Quantity
QS
Q
Quantity
51
What’s 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).
52
What’s 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).
53
What’s 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.
54
Conclusion
Competitive bidding schemes that allow
competition in the subsidized markets are
likely welfare reducing and should be
avoided.
55
Some Caveats
I’ve assumed that competitive bidding
renders a zero profit equilibrium, like it
should in theory (but may not in
practice).
I’ve assumed competition only affects
prices.
Administrative costs are ignored.
Strategic bidding is absent.
I’ve assumed any subsidy cap is not
binding.
56
2006 Annual U.S. Telecoms Symposium
Grand Hyatt Conference Center
Washington DC
December 6, 2006