Fixed-Mobile Substitution and Lessons for Broadband Aniruddha (Andy) Banerjee Vice President, Analysis Group Eighth ACCC Regulatory Conference The Evolution of Regulation Gold Coast, Queensland, Australia July 26 -27, 2007 BOSTON CHICAGO WASHINGTON DALLAS DENVER LOS ANGELES MENLO PARK MONTREAL NEW YORK SAN FRANCISCO
Agenda What is Fixed-Mobile Substitution (FMS)? Trends in FMS Substitution and Complementarity The Enigmatic and Elusive Cross-Price Elasticity Market Definition/Antitrust Policy Implications of FMS in a Broadband World 1
What is Fixed-Mobile Substitution (FMS)? 2
Background: Evolution of Telecommunications Now Before Wireline Networks Wireless Networks Wireline Networks Television Broadcast and Cable Networks Internet Backbone 3
Background: Evolution of Telecommunications Now Before Fixed Voice Triple Fixed Voice Play Data Quad Video Play Mobile Voice 4
Telecom Competition: Tale of Two Strategies Fixed-Mobile Substitution (FMS) Fixed Mobile Operator Strategy: Displace 5
Telecom Competition: Tale of Two Strategies Fixed-Mobile Convergence (FMC) Fixed Mobile Fixed Operator Strategy: Integrate 6
Nature of Substitution in FMS ¨ Network access vs. usage (calls, minutes of use) ¨ Price and non-price (lifestyle, mobility) drivers ¨ Technological factors (leapfrogging) ¨ Different types of economic substitution n “Cut the cord” (ex post, access and usage) n strict usage substitution n “Straight to mobile” (ex ante, choice of service) 7
Trends in FMS 8
Fixed and Mobile Growth Year Fixed Lines 1990 1999 2002 2005 0. 91 billion 1. 09 billion 1. 23 billion Mobile Subscribers negligible 0. 41 billion 1. 17 billion 2. 18 billion Source: ITU 9
Fixed and Mobile Growth: Contrasts Developing Country Example: China, India, Indonesia Year Fixed Lines Mobile Subscribers 275 million Dec 270 million 2003 Mar 416 million 689 million 2007 Developed Country Example: United States CAGR 13. 2% 28. 8% Year Fixed Lines Household Penetration Rate 2000 192 million 97. 6% 2005 175 million 94. 8% Source: Telegeography, FCC 10
Evidence of FMS: Empirical Research ¨ Mixed evidence of substitution (FMS in access or usage) and complementarity ¨ Complementarity findings n Early years of mobile telephony n Developed countries ¨ Substitutability findings n As mobile telephony has grown over time n As cross-network externalities have diminished n Developing countries, now in developed countries ¨ Mobile is substitute for n fixed long distance (usage) n second fixed lines (network access) 11
Substitution and Complementarity The Enigmatic and Elusive Cross-Price Elasticity 12
Three Questions About FMS “Evidence” ¨ Are FMS trends sufficient to draw conclusions about n n economic (relative price-based) substitution? state of intermodal competition? ¨ Can econometric studies reliably determine whether fixed and mobile n n are substitutes or complements? remain so over time? ¨ How should findings of FMS inform policymaking in n n voice-only context? triple or quadruple play context? 13
Substitutes and Complements: Commonly Accepted Diagnostic Cross-price elasticity of demand between two goods X and Y Percent change in demand of one given percent change in price of the other Positive cross-price elasticity → substitute Negative cross-price elasticity → complement These statements are only true for Hicksian, not Marshallian, measures of the cross-price elasticity 14
Problem of False Positives: Complements Could Actually be Substitutes! ¨ Correlations of stocks can be misleading n if fixed and mobile stocks both rise → complementarity? ¨ Not necessarily in some circumstances n n rising incomes lead consumers to buy more of both with no change in relative prices marketing campaigns boost first-time consumers of both fixed and mobile even though existing consumers don’t switch strongly downward-trending prices for fixed and mobile create parallel surges in demand total bill effect (when telecom demand is separable) 15
Problem of False Positives: Complements Could Actually be Substitutes! ¨ Fixed and mobile access are n n apparent complements in developed countries, even though usage may be substitutes apparent substitutes in developing countries, even though usage may be complements or unrelated ¨ No natural experiment to permit reliable resolution of this problem 16
The Cross-Price Elasticity Problem ¨ Notoriously hard to determine even in best of circumstances ¨ Especially so (as in telecom) when n n prices remain stable over time (regulatory reasons) move in unison (competitive or technological reasons) ¨ Only Hicksian (compensated) cross-price elasticities reveal “true” substitutes or complements, but harder to estimate ¨ Marshallian (uncompensated) cross-price elasticities more commonly used, but can provide opposite inference from Hicksian elasticities 17
The Cross-Price Elasticity Problem ¨ Only Hicksian cross-price effects are always symmetric; Marshallian cross-price effects need not be ¨ Although Hicksian cross-price effects are symmetric, corresponding cross-price elasticities need not be ¨ Marshallian cross-price elasticities may indicate “substitute” in one direction but “complement” in the other ¨ Even when Hicksian and Marshallian cross-price elasticities agree in sign, they are usually different in magnitude ¨ Because cross-price elasticities are asymmetric in magnitude, may be important to know in which direction the relationship (substitute or complement) is stronger 18
Market Definition/Antitrust Policy Implications of FMS 19
Three Impact Areas ¨ Product market definition and granularity ¨ Product market definition from the policymaker’s perspective n story of intermodal competition ¨ Complementarity of network access and usage demand in granular markets n regulate or not regulate mobile termination charges? 20
Product Market Definition and Granularity Telephony Fixed-to-Fixed-to-Mobile Telephony Mobile-to-Fixed Mobile-to-Mobile 21
Market Definition: Policymaker’s Perspective Policy issues: ¨ Relax/repeal regulation of incumbent fixed network? ¨ Evidence of sufficient (intermodal) competition? ¨ Who/what belongs in the relevant economic market? Key indicator: ¨ Demand substitution, e. g. , positive (and “healthy”) crossprice elasticity Market definition questions: ¨ Single economic market for all voice? ¨ Separate markets for fixed voice, mobile voice? 22
Case: AT&T Wireless/Cingular Merger 2004 FCC’s issue: ¨ Fixed voice belongs in market for mobile voice? ¨ Mobile voice belongs in market for fixed voice? Bell. South testimony in favor of merger: ¨ In 2004, no evidence that fixed voice constrains mobile voice pricing, does not belong in mobile voice market FCC’s decision: ¨ Agrees with Bell. South n n n limits relevant market to mobile voice providers only finds sufficient competition in that market approves merger 23
Case: Deregulation of Bell. South’s Fixed Voice Services 2004 State regulator’s issue: ¨ Mobile voice belongs in market for fixed voice (intermodal competition)? Bell. South testimony in favor of deregulation: ¨ Strong evidence that n n n mobile voice constrains fixed voice pricing FMS mobile voice belongs in fixed voice market 24
Case: Deregulation of Bell. South’s Fixed Voice Services 2004 Comp. Tel/ASCENT testimony opposing deregulation: ¨ If fixed voice does not belong in mobile voice market (citing Bell. South testimony in AT&T Wireless/Cingular merger), then opposite also true (argument of symmetry of cross-price elasticities) ¨ Confusion of symmetry of cross-price effects with that of cross-price elasticities! State regulator’s decision: ¨ Reject claim of symmetry and arguments based thereon ¨ Favor direct evidence of substitution ¨ Grant deregulation with conditions 25
Access-Usage Complementarity: Regulation of Mobile Termination Access Monopoly Problem: ¨ In Calling Party Pays (CPP) countries, unregulated mobile operators enjoy termination access monopoly ¨ High mobile termination charges (MTC), particularly detrimental for fixed-to-mobile (FTM) voice calling Possible policy responses: ¨ Direct regulation of MTC ¨ Receiving Party Pays (RPP) ¨ Bill and keep 26
Direct Regulation of MTC In favor: Opposed: ¨ Regulators in many CPP countries (UK, Japan, Australia, New Zealand) ¨ Many economists ¨ Not much cross-network externalities left to lose, given high penetration rates ¨ Pass-through of lowered MTC n n n reduces cost of FTM calls Increases FTM call volume increases demand for mobile subscribership (access-usage complementarity effect) ¨ Effective with or without “waterbed effect” ¨ High MTC enables n n n subsidies to mobile network access Increases mobile subscribership Generates greater FTM calling (access-usage complementarity in opposite direction) ¨ What if lowered MTC are not passed through into retail FTM calling prices? ¨ “Waterbed effect”exists n n MTC profits competed away Unsubsidized access may suppress mobile subscribership 27
Direct Regulation of MTC Can it be effective? ¨ Clearly, an empirical issue ¨ Access-usage complementarity n n n Cross-price elasticity between demand for FTM calling and demand for mobile network access Does complementarity exist in both directions (symmetric in sign)? How strong is the complementarity (symmetric in magnitude)? ¨ Can pass-through of reduced MTC into retail FTM price be assured and monitored? ¨ What are the indirect costs of regulation and monitoring relative to bill and keep? 28
Direct Regulation of MTC Can be shown that the following matter: ¨ Own-price elasticity of demand for mobile network access ¨ Cross-price elasticity of demand for FTM calling with respect to MTC (which affects FTM price) ¨ Number of mobile subscribers (network externalities) ¨ Volume of FTM calls (call externalities) ¨ Effective price (net of subsidy) of mobile network access ¨ Profit margin from mobile network access (can be negative if subsidized)) ¨ Profit margin from terminating FTM calls (can be zero if MTC set at cost) 29
FMS in a Broadband World 30
Broadband Access High-speed, packet-based access to voice, data, video services Definitions (based on speed of access) vary Source of definition Access speed FCC 200+ kbps OECD 256 kbps downstream ITU 1. 5 -2 Mbps Japan, Korea 8+ Mbps Broadband delivered over fixed (wireline, cable, powerline), mobile, and satellite systems 31
Broadband Technologies: Examples Fixed Systems Mobile Systems ¨ DSL ¨ Fixed wireless (LMDS) ¨ Cable modem ¨ Power line ¨ Fiber (FTTH/FTTP) ¨ Wi-Fi (UMA) ¨ Wi-Max ¨ HSDPA (3 G+ successor to GSM) ¨ EV-DO (3 G successor to CDMA) 32
FMS in Broadband Important developments ¨ IP-based service provision ¨ Need for higher-bandwidth access networks ¨ Fixed systems n n VDSL GPON (control and intelligence shifts to edges of network) ¨ Mobile systems n n Wi-Fi (WLAN) and fixed and mobile Wi. Max Picocells (enterprise customers) and femtocells (SOHO) ¨ Consequence: New substitution opportunities n n n fixed vs. fixed wireless fixed vs. mobile fixed wireless vs. mobile 33
FMS in Broadband: Policy Implications Service definition ¨ Electronic communication (triple or quadruple play) vs. voice, data, or video individually n Imperfect, but close, substitutes develop under the service level (e. g. , voice, email, text messaging, social networks) Impetus for deregulation or regulatory re-direction? ¨ Competition based on access rather than service (commoditized) ¨ Consumers have greater access/service options and control ¨ Terminating access monopoly in CPP countries dissipates ¨ Network externalities resurgent as consumers become originators and storers of content ¨ Danger that continuing ex ante regulation can pick winners 34 and losers among technology platforms
Contact Information Aniruddha (Andy) Banerjee, Ph. D. Vice President, Analysis Group, Inc. 111 Huntington Avenue, 10 th Floor Boston, MA 02199, USA Tel: +1 617 425 8222 Fax: +1 617 425 8001 abanerjee@analysisgroup. com www. analysisgroup. com 35
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