Introduction The Model Subgame Perfect Nash Equilibria Conclusions

Can Access Price Indexation Promote Ecient

Investment on Next Generation Networks?
David Henriques
February 22, 2011
Preliminary Work
The Apritel Award (1st honorable mention) is acknowledged
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Motivation (1): Trade-o between static and dynamic
eciency
It is essential to establish clear regulatory
guidelines to encourage investment in next
generation access networks, while ensuring that
such networks remain open and competitive in the
interest of consumers. Neelie Kroos, European
Commissioner for Digital Agenda.
Benevolent regulators choosing access prices (to next
generation networks) face a trade-o between static and
dynamic eciency.
Static eciency: retail prices equal marginal cost.
Dynamic eciency: market outcome equals the socially
optimal investment.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Motivation (2): Previous attempts to encourage
investment on NGN
Regulatory Holidays: one operator is granted with the
exclusive right to explore (temporarily) the new network alone.
Cases of Germany with Deutsche Telekom and Spain with
Telefonica. Drawback: retail price increases (monopoly
pricing).
Cost-sharing: let a group of operators invest jointly on
shared infrastructures (French case). Drawback: operators
wait others to invest (free riding).
Public-private partnership: Government provides funding to
kick-o the project and the private sector is expected to
construct and operate the network. Cases: Portugal (credit
line of EUR 800million), Australia (Gov. is the majority
shareholder), Singapor and US (invested USD 7.2billion to
support broadband build-up).
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Motivation (2): Previous attempts to encourage
investment on NGN
Regulatory Holidays: one operator is granted with the
exclusive right to explore (temporarily) the new network alone.
Cases of Germany with Deutsche Telekom and Spain with
Telefonica. Drawback: retail price increases (monopoly
pricing).
Cost-sharing: let a group of operators invest jointly on
shared infrastructures (French case). Drawback: operators
wait others to invest (free riding).
Public-private partnership: Government provides funding to
kick-o the project and the private sector is expected to
construct and operate the network. Cases: Portugal (credit
line of EUR 800million), Australia (Gov. is the majority
shareholder), Singapor and US (invested USD 7.2billion to
support broadband build-up).
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Motivation (2): Previous attempts to encourage
investment on NGN
Regulatory Holidays: one operator is granted with the
exclusive right to explore (temporarily) the new network alone.
Cases of Germany with Deutsche Telekom and Spain with
Telefonica. Drawback: retail price increases (monopoly
pricing).
Cost-sharing: let a group of operators invest jointly on
shared infrastructures (French case). Drawback: operators
wait others to invest (free riding).
Public-private partnership: Government provides funding to
kick-o the project and the private sector is expected to
construct and operate the network. Cases: Portugal (credit
line of EUR 800million), Australia (Gov. is the majority
shareholder), Singapor and US (invested USD 7.2billion to
support broadband build-up).
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
The Research Question
This paper deals with a problem of underinvestment in shared
infrastructures.
How to encourage investment in shared network
infrastructures without lessening downstream price
competition?
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Main Result
For a given retail price, a linear access price (per end-user)
rule on investments,
a
i
= xI
i
yI
j
, i 6= j (1)
can: i) expand total investment on network infrastructure
(bre coverage), and, ii) enhance social welfare, vis-a-vis a
xed access price (per end-user) a

.
The indexation approach, vis-a-vis a xed access price rule,
rewards investors twofold by allowing them to: i) charge more
to provide access to other operators and, ii) pay less to get
network access from other operators.
Indexing access charges to investments takes competition to
another level - the investment stage.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Related Literature (1)
De Bijl and Peitz (2004) explored situations of one-way access
in which an integrated operator owns a network infrastructure
and sells access directly to end-users and to a downstream
operator.
They show that it is possible to provide stronger incentives to
the integrated operator to invest on infrastructure quality, by
increasing the sensitivity of the regulated access price to the
network quality.
Nonetheless, they do not construct any explicit form on how
the access price should depend on quality.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Related Literature (2)
Jeon and Hurkens (2008) studied the retail benchmarking
approach.
They proposed access pricing rules that determine the access
price as function of the retail prices charged by both networks.
a
ij
= h
1
p
i
+ h
2
p
j
+ h
3
c + h
4
, i 6= j .
Such indexation induces the market outcome to achieve the
socially ecient price at the retail level.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Related Literature (3)
Sauer (2011) focus on the regime of endogenous access
charges, per user, contingent on rms investment levels and,
on the regime of investment cost-sharing with lump-sum
charges.
Sauer shows that in the former it is possible to reach socially
ecient investments without distorting downstream
competition, whilst in the latter, despite the investment level
is higher than under xed access charges, it is below the
socially ecient investment.
However, the author assumes that the market is fully covered
(Hotelling model without distortions on consumption) and
access charges are dened according to,
a
i
= I
i
.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Assumptions (1)
There are 2 operators (denoted by 0 and 1) selling broadband
(bre) connection to end-users.
Investment expands the number of areas, e.g. cities, covered
by bre, where I I
0
+ I
1
, and I
i
corresponds to the number
of cities where operator i has invested and I is the total
number of cities covered by bre.
The consumer surplus in each city is given by
CS U (q
0
, q
1
)
1

i =0
p
i
q
i
, (2)
U (q
0
, q
1
)
0
q
0
+
1
q
1

0
q
2
0
+ 2q
0
q
1
+
1
q
2
1
_
2
. (3)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Assumptions (2)
From (2) and (3), demand functions can be derived and
written as
_
q
0
= A Bp
0
+ Dp
1
q
1
= A Bp
1
+ Dp
0
.
(4)
The investment cost to operator i = 0, 1, is given by
technology
C (I
i
) = c
I
2
i
2
. (5)
Operators compete in prices in all areas, regardless who has
made the investment in each city.
Operator i s mg cost of serving end-users =
_
0,
a
j
,
if end-user in i s area
all other areas.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Timing of the model
I. The regulator denes the access price rule, per end-user,
that operator i pays to j .
II. Operators invest simultaneously and non-cooperatively
in non-duplicable network infrastructure, which we inter-
pret as NGN infrastructure. Immediately after, operators
observe the investment outcome.
III. Operators compete simultaneously and non-
cooperatively in retail prices.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under Fixed Access Price (1)
STAGE III: RETAIL PRICE COMPETITION
Operator i s problem,
max
p
i

i
= (I
0
+ I
1
) p
i
q
i
+ aq
j
I
i
aq
i
I
j
c
I
2
i
2
(6)
In equilibrium,
_
_
_
p

0
=
(2AB+AD)(I
0
+I
1
)+
(
2B
2
+D
2
)
aI
1
+3aBDI
0
(I
0
+I
1
)(2BD)(2B+D)
p

1
=
(2AB+AD)(I
0
+I
1
)+
(
2B
2
+D
2
)
aI
0
+3aBDI
1
(I
0
+I
1
)(2BD)(2B+D)
(7)
For ease of exposition, assume that
A = B = 1 and D = 0.5. (8)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under Fixed Access Price (2)
STAGE II: INVESTMENT
max
I
i

i
= (I
0
+ I
1
) p

i
q

i
+ aq

j
I
i
aq

i
I
j
c
I
2
i
2
(9)
In equilibrium, we get
_
I

0
=
1
360c
(160 + a (312 153a))
I

1
=
1
360c
(160 + a (312 153a)) .
(10)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under Fixed Access Price (3)
STAGE I: REGULATORS CHOICE
Suppose that the regulator is welfare maximizer, therefore solves
max
a
8
3
W

= (I

0
+ I

1
) U (q

0
, q

1
) c
_
(I

0
)
2
2
+
(I

1
)
2
2
_
0.5 1.0 1.5 2.0 2.5
-1
1
2
3
a
W
Solution is a

= 0.5023. (11)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
The Pareto Ecient Solution VS Market Equilibrium under
Fixed Access Price
We nd the rst-best solution by solving
max
q
0
,q
1
,I
0
,I
1
W (I
0
+ I
1
) U (q
0
, q
1
) c
_
I
2
0
2
+
I
2
1
2
_
. (12)
a

= 0.5023, (13)
I

i
=
0.772 54
c
<
2
c
= I
opt
i
, I

=
1. 545 1
c
<
4
c
= I
opt
,(14)
p

i
= 0.917 82 > 0 = p
opt
i
, (15)
q

i
= 0.541 09 < 1 = q
opt
i
, Q

= 1. 082 2 < 2 = Q
opt
,(16)

i
=
0.468 91
c
, U

= 1. 578 8 < 2 = U
opt
, (17)
W

=
1. 842 6
c
<
4
c
= W
opt
. (18)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under the Indexation Approach (1)
Let the access price received by operator i , per end-user of
operator j using i s infratructure, be dened by
a
i
xI
i
yI
j
, (19)
where (x, y) is the pair of regulatory parameters.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under the Indexation Approach (2)
STAGE III: RETAIL PRICE COMPETITION
Operator i s problem,
max
p
i

i
= (I
0
+ I
1
) p
i
q
i
+ a
i
q
j
I
i
a
j
q
i
I
j
c
I
2
i
2
(20)
In equilibrium,
_
p

0
=
1
I
0
+I
1
D
2
I
1
a
1
+2ABI
0
+2ABI
1
+ADI
0
+ADI
1
+2B
2
I
1
a
1
+3BDI
0
a
0
(2BD)(2B+D)
p

1
=
1
I
0
+I
1
D
2
I
0
a
0
+2ABI
0
+2ABI
1
+ADI
0
+ADI
1
+2B
2
I
0
a
0
+3BDI
1
a
1
(2BD)(2B+D)
(21)
Note that
a
0
xI
0
yI
1
, (22)
a
1
xI
1
yI
0
. (23)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under the Indexation Approach (3)
STAGE II: INVESTMENTS
max
I
i

i
= (I
0
+ I
1
) p

i
q

i
+ a
i
q

j
I
i
a
j
q

i
I
j
c
I
2
i
2
(24)
Assuming that A = B = 1 and D = 0.5, the operator i s FOC
comes as
_
351x
2
+ 135y
2
486xy
_
I
2
i
+ (360c 624x + 120y) I
i
160 = 0,
(25)
while the SOC, in the symmetric equilibrium, has to hold the
following inequality,

1
600
_
600c 1040x +
_
1131x
2
+ 75y
2
1170xy
_
I
i
_
< 0. (26)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under the Indexation Approach (4)
STAGE I: REGULATORY REGIME
Suppose that the regulator wants to implement I

such that
I

=
3.9
c
>
1. 545 1
c
= I

, (27)
keeping the same retail prices as under the xed access approach.
Hence, in equilibrium, it must be
I

i
=
1.95
c
, (28)
p

i
= p

i
= 0.917 82 )a

= 0.5023. (29)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Market Equilibrium under the Indexation Approach (5)
STAGE I: REGULATORY REGIME
a
i
xI
i
yI
j
(30)
a
0
= a
1
= a

, (31)
(x y) 1.95 = 0.5023 , (32)
y = x 0.257 59. (33)
0.0 0.5 1.0 1.5
0.0
0.5
1.0
1.5
x
y
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Access Price Indexation VS Fixed Access Price
Proposition 1: For a given retail price, a linear access price rule
on investments can: i) expand total investment on network
infrastructure, and, ii) enhance social welfare, vis-a-vis a xed
access price.
For c = 1, the regulatory regime a
i
= 0.668 78I
i
0.411 19I
j
,
i 6= j , i , j = 0, 1 implements
I

i
= 1.95 > 0.77254 = I

i
, (34)
a

i
= 0.502 3 = a

, (35)
p

i
= 0.917 82 = p

i
, (36)
q

i
= 0.541 09 = q

i
, Q

= Q

= 2 0.541 09, (37)

U

= U

= 1. 578 8, (38)

i
= 0.03558 1 < 0.468 91 =

i
, (39)
W

= 2. 354 8 > 1. 842 6 = W

. (40)
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Access Price Indexation VS Regulatory Holidays
Proposition 2: The regulatory holidays regime performs worse
than the proposed access price approach regarding: investments
(bre coverage), retail prices and social welfare.
The monopolist i solves
max
p
i

mon
i
= I
i
p
i
(q
i
+ q
j
) c
I
2
i
2
.
At the investment stage the monopolist solves
max
I
i

mon
i
= I
i
p
mon
i
_
q
mon
i
+ q
mon
j
_
c
I
2
i
2
.
For c = 1, we have
I

i
= 1.95 > I
mon
i
= 1 > 0.772 54 = I

i
,
p
mon
i
= 1 > 0.917 82 = p

i
= p

i
,
W

= 2. 354 8 > W
mon
= 2 > 1. 842 6 = W

.
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Takeaway: an idea for regulation
The contribution of this paper lies in the new access price
formulation.
Under the indexation approach, investors are rewarded with a
competitive advantage when competing in prices in the
downstream market. This makes operators to compete in
investment levels, which does not happen under the xed
access price approach.
Dont give holidays to operators, give them incentives to
compete!
Introduction The Model Subgame Perfect Nash Equilibria Conclusions
Time for questions and suggestions
THANK YOU!