Quality upgrades and bypass under mandatory access

We analyze the interaction between the incumbent’s incentive to upgrade the quality of its network and the entrant’s incentive to build a bypass network when the regulator sets a two-part access tariff to the incumbent’s network. Under this context, the entrant’s investment in a bypass network is delayed with a higher incumbent’s investment in quality. Moreover, the possibility of investment in a bypass network by the entrant has a positive effect on the incumbent’s incentive to upgrade quality. We show that a regulator cannot achieve the first best with a constant access tariff. If he wants to design an alternative welfare improving access tariff, he should set an access fee increasing (decreasing) in quality if the business-stealing effect of quality upgrades is weak (strong). The analysis suggests that if the entrant’s investment costs are declining or its market share is increasing over time, it is not always optimal to require the incumbent to lease facilities at cost-based prices.     

The welfare effects of entry: the role of the input market

In a successive Cournot oligopoly, we show the welfare effects of entry in the final goods market with no scale economies but with cost difference between the firms. If the input market is very concentrated, entry in the final goods market increases welfare. If the input market is not very concentrated, entry in the final goods market may reduce welfare if the entrant is moderately cost inefficient. Hence, entry in the final goods market is more desirable if (1) the input market is very concentrated or (2) the cost difference between the incumbents and the entrant is either very small or very large. It follows from our analysis that entry increases the profits of the incumbent final goods producers if their marginal costs are sufficiently lower than the entrant’s marginal cost.     

Strategic sourcing for entry deterrence and tacit collusion

By sourcing key intermediate goods to a potential entrant, an incumbent firm can credibly and observably commit to an intense post-entry competition, thereby deterring the entry. At the same time, a collusive effect exists, whereby the entrant’s loss from staying out of the final-good market is compensated through their sourcing transaction. We find that entry-deterring sourcing in general has ambiguous effect on social welfare. However, there exist scenarios where it enhances not only social welfare, but also consumers’ surplus.     

Fiber deployment in Spain

Next generation access networks will be critical for future economic growth and access to these infrastructures will have major consequences for territorial and social cohesion. This paper examines the economic and competition determinants that serve as incentives for operators to invest in fiber-to-the-home technology. We draw on a dataset comprising 6603 Spanish municipalities with access to broadband services to examine the incumbent’s (Telefónica) deployment of fiber in the period 2010–2013. We show that local loop unbundling competition had a strong positive impact on Telefónica’s fiber deployment, while bitstream competition had a negative effect. Moreover, the incumbent was more likely to invest in municipalities with a large presence of cable operators. We also consider how the municipalities’ sociodemographic characteristics affected the operator’s deployment decision. While market size and population density had a positive effect on investment, the level of unemployment and the percentage of elderly population had a negative impact.     

Pricing inputs to induce efficient Make-or-Buy decisions

We investigate input pricing regimes that induce efficient Make-or-Buy decisions by entrants when there is constant returns in the production of the input(s) and simultaneous noncooperative price competition in downstream retail markets. Necessary and sufficient conditions for efficient Make-or-Buy decisions are derived. The necessary condition shows that input prices are relevant for Make-or-Buy decisions except under restrictive and often unverifiable assumptions on the demand structure, and that the least informationally-demanding way to ensure efficient Make-or-Buy decisions is to price inputs at marginal cost provided changes in the entrant’s cost have a “normal” effect on the entrant’s profit. The conditions also show that pricing the incumbent’s input at the entrant’s marginal cost always ensures efficient Make- or-Buy decisions. The extent to which input prices can depart from marginal cost while still inducing efficient Make-or-Buy decisions increases with the efficiency differential between the incumbent and entrant and with the demand displacement ratio.      

Unbundling the local loop

We study competition for high bandwidth services in the telecommunications industry by introducing the possibility of unbundling the local loop, where leased lines permit the entrant to provide services without building up its own infrastructure. We use a dynamic model of technology adoption and study the incentives of the entrant to lease loops and compete “service-based”, and/or to build up a new and more efficient infrastructure and compete “facility-based”, given the rental price.We show that the incumbent sets too low a rental price for its loops; hence, the entrant adopts the new technology too late from a social welfare perspective. The distortion may appear not only on the timing of technology adoption but also on the type (quality) of the new technology to be adopted. We also show that while regulating the rental price may suffice to achieve socially desirable outcomes, a sunset clause does not improve social welfare.     

Imperfect legal unbundling of monopolistic bottlenecks

We study an industry with a monopolistic bottleneck supplying an essential input to several downstream firms. Under legal unbundling the bottleneck must be operated by a legally independent upstream firm, which may be partly or fully owned by an incumbent active in downstream markets. Access prices are regulated but the upstream firm can perform non-tariff discrimination. Under perfect legal unbundling the upstream firm maximizes only own profits; with imperfections it is biased and to some extent accounts also for the incumbent’s downstream profits. We show that increasing the incumbent’s ownership share increases total output if the upstream firm’s bias is sufficiently small, while otherwise effects are ambiguous. Stronger regulation that reduces the bias without changing ownership shares generally increases total output. We also endogenize the bias and show that it can depend non-monotonically on the ownership share.     

Welfare effects of unbundling under different regulatory regimes in natural gas markets

In this paper, we develop a theoretical model that enriches the literature on the pros and cons of ownership unbundling vis-à-vis lighter unbundling frameworks in the natural gas markets. For each regulatory framework, we compute equilibrium outcomes when an incumbent firm and a new entrant compete à la Cournot in the final gas market. We find that the entrant’s contracting conditions in the upstream market and the transmission tariff are key determinants of the market structure in the downstream gas market (both with ownership and with legal unbundling). We also study how the regulator must optimally set transmission tariffs in each of the two unbundling regimes. We conclude that welfare maximizing tariffs often require free access to the transmission network (in both regulatoy regimes). However, when the regulator aims at promoting the break-even of the regulated transmission system operator, the first-best tariff is unfeasible in both regimes. Hence, we study a more realistic set-up, in which the regulator’s action is constrained by the break-even of the regulated firm (the transmission system operator). In this set-up, we find that, for a given transmission tariff, final prices in the downstream market are always higher with ownership unbundling than with legal unbundling.     

The impact of compatibility on innovation in markets with network effects

ABSTRACT

This article analyses the relationship between compatibility and innovation in markets with network effects using a model of competition with endogenous R&D, commercialization and compatibility. Compatibility is a mutual decision between firms and demand is partially dependent on overall consumption across compatible networks. Incumbent acquisition of an innovation or profit from entry provides entrepreneurs with an incentive for developing technological improvements and entrepreneurs receive greater returns if larger incumbents offer compatibility with their installed base. But for sufficiently weak network effects a large incumbent increases demand for its own product by denying compatibility to rivals. As a result, a credible threat of incompatibility reduces the entrepreneur's reserve to sell an innovation, but can also increase offers from smaller incumbents to acquire the innovation if it also avoids an incompatibility response from a larger incumbent. In response, entrepreneurs adjust their research effort in order to target a favourable compatibility regime that maximizes profit from entry or offers to acquire the innovation from incumbents. This leads to a complex relationship between the strength of network effects, innovation incentives, the entrepreneur's ambition for improvement and potentially disrupting the compatibility regime.     

Bidding between incumbent and entrant

Facing an informed incumbent who has cost advantages in two different states, the uninformed entrant bids cautiously due to the incumbent’s cost advantage in the low cost state. The incumbent bids aggressively, earning additional profits because of his cost advantages.     

Are input prices irrelevant for make-or-buy decisions?

The 1996 Telecommunications Act requires incumbent providers to lease network inputs to rivals at cost-based prices in order to jump-start competition. Sappington (Sappington, D. (2005). American Economic Review, 95(5), 1631–1638) uses the Hotelling model to show that input prices are irrelevant for an entrant’s decision to make or buy an input required for downstream production. We show that this result depends upon the particular model of competition employed. Specifically, input prices are not necessarily irrelevant in the Bertrand vertical differentiation model and are not irrelevant in the Cournot model. It follows that departures from cost-based input prices may distort entrants’ make-or-buy decisions in settings of practical interest.      

Competition Between Exclusive Religions: The Counter‐Reformation As Entry Deterrence

This article sets forth a theory of competition between exclusive religions as an entry deterrence game, in which the incumbent may find it profitable not to accommodate but to deter the competitor's entry by precommitting to sufficient capacity expansion in the event of entry. If entry costs are high enough, deterrence is optimal and the incumbent remains a monopolist, although the entry threat distorts its effort upward. The model is then applied to the Catholic Church's reaction to the Protestant Reformation. It is argued that the model provides a better fit to the historical data of the Counter‐Reformation than the price‐cutting model proposed by economists Ekelund, Hébert and Tollison ( 2004 , 2006 ).     

Sustainable positive profit multiple-price strategies in contestable markets

One of the most important features of contestable market is the incumbent's inability to react to entry. While in the traditional literature, this prevents the incumbent from earning positive profits, in multiple price setting it allows him to make a binding commitment to maintain his strategy even if entry occurs. It is shown that as a result of this pre-commitment, any natural monopolist can find a multiple price strategy that yields positive profit, and prevents entry.     

Entry Threats and Inefficiency in ‘Efficient Bargaining’

We study limit pricing in a model of entry with asymmetric information, where the incumbent firm's wage is endogenously determined through ‘efficient bargaining’ with its union. In the presence of entry threat, the incumbent firm‐union pair may face a conflict between rent sharing and transmitting its cost information. When the wage is not observable to outsiders and employment is the only signalling instrument, over‐employment features in all entry deterring contracts. When the wage is also observable, information transmission becomes easier. Most of the time, then, but not always, the efficient contract deters (induces) entry against the low (high) cost incumbent.     

A Dynamic Model of Incumbent LEC Response to Entry Under the Terms of the Telecommunications Act of 1996

This paper dynamically models an incumbent Local Exchange Carrier's (LEC's) ability to control market entry with a profit squeeze. The model is consistent with the post-Telecommunications Act of 1996 local exchange market. The model shows that an unconstrained incumbent could choose output prices and input costs to discourage an entrant's output-market production. The impact of a regulatory constraint on incumbent behavior is examined. It is concluded that cost-based input prices may lead to little growth in the entrant's self-provision of inputs and that continuing oversight of output and input prices may be necessary.     

Entry and espionage with noisy signals

We analyze the effect of industrial espionage on entry deterrence. We consider a monopoly incumbent who may expand capacity to deter entry, and a potential entrant who owns an Intelligence System. The Intelligence System (IS) generates a noisy signal based on the incumbentʼs actions. The potential entrant uses this signal to decide whether or not to enter the market. The incumbent may signal-jam to manipulate the likelihood of the noisy signals and hence affect the entrantʼs decisions. If the precision of the IS is commonly known, the incumbent benefits from his rivalʼs espionage. Actually, he benefits more the higher is the precision of the IS while the spying entrant is worse off with an IS of relatively high quality. When the IS quality is private information of the entrant, the incumbent is better off with an IS of high expected precision while the entrant benefits from one of high quality. In this case espionage makes the market more competitive.     

Entry deterrence through credit denial

Firms in oligopoly can use debt to commit to a strategic position that negatively affects rival firms and improves profitability. In this paper, I show that an incumbent firm can deter entry by using debt to commit to such a low price that an entrant's lender will not finance entry, even if the entrant's expected profit from entry is positive. Empirical evidence shows that concentration and debt are positively related in several industries, indicating that debt may be used to reduce competition.     

ENTRY AND QUALITY SIGNALLING WHEN ONLY SOME CONSUMERS ARE INFORMED OF THE ENTRANT'S QUALITY

This paper focuses on competition between an incumbent and an entrant when only the entrant's quality is unknown to (some) consumers. The incumbent may or may not know the entrant's quality. The model reveals a separating equilibrium where the entrant's high price signals its high quality when the proportion of informed consumers is at some intermediate value. The case in which the incumbent knows the entrant's quality generates two additional equilibria. When the proportion of informed consumers is large enough, firms choose their prices as in the complete information case. The entrant's high price in combination with the incumbent's low price signals the entrant's high quality. When the proportion of informed consumers is at some intermediate value, the incumbent's high price signals the entrant's low quality, while its low price signals the entrant's high quality. Interestingly, we find that entry may be facilitated with informational product differentiation.     

Tariff Policy and the Foreign Entry Decision in the Presence of a Cost-Based Informational Asymmetry

The paper demonstrates that the standard prediction on the relation between tariff rates and the mode of foreign entry—exports or direct investment—may not hold in the presence of incomplete information. A foreign firm lacks full information on the cost structure of an informed incumbent firm located in the domestic (potential) host country. Within a two‐period model, the local incumbent may behave in a manner which keeps the potential foreign entrant uninformed of its cost structure. In such a pooling equilibrium, the uninformed foreign firm either refrains from entering altogether or serves the host country via exports at tariff rates which would, otherwise under complete information, induce entry via direct investment. When entry mode is altered, other standard full‐information effects of trade policy may also no longer hold.     

Entry Solicitation and Deterrence in R&D Competition with Spillovers

The purpose of this note is to examine incumbent behaviour and patterns of entry under R&D competition with spillovers. We find that, in addition to blockading, deterring and accommodating entry, the incumbent may also solicit entry. Entry solicitation occurs when the incumbent strategically alters its R&D commitment in order to take advantage of the spillover generated by the entrant's subsequent R&D investment. Although our results are placed in the context of R&D with spillovers, they are applicable to a wider class of models involving positive externalities, particularly network externalities.
JEL Classification Numbers: L12, O31.