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Progressive entry and the incentives to invest in alternative infrastructures

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Abstract

In this paper we study an entrant’s incentives to build a network infrastructure, when there is an initial phase of service-based competition where it leases access to the incumbent’s infrastructure. We build a model in which the phase of service-based competition allows the entrant to step into the market by progressively acquiring market experience. We show that the acquisition of experience in the phase of service-based competition delays the entrant’s investment when the prospects for infrastructure investment are good, and accelerates investment otherwise. We also show that when the acquisition of experience depends on the entrant’s current customer base and facility-based entry is a long-term possibility, setting a low access price can accelerate the entrant’s investment.

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Notes

  1. For example, in the broadband market, unbundling of the local loop (i.e., regulated access to the incumbent’s copper local loop) has become mandatory in most industrialized countries. Recently, the European Commission also issued a Recommendation requiring some kind of regulated access to next generation access (fibre) networks (EU 2010).

  2. See Cave (2006). This approach is often referred to as the stepping stone argument in the US.

  3. As Bourreau et al. (2010) argue, the second assumption behind the ladder of investment approach is that the regulator has the instruments to neutralize the replacement effect.

  4. See also Valletti (2003) and Guthrie (2006).

  5. Experience acquisition is exogenous in their setting.

  6. See, for example, Hazlett and Bazelon (2005) and Hausman and Sidak (2005) for the US, and Crandall and Sidak (2007) and Bacache et al. (2013) for Europe. The only exception is the study by Distaso et al. (2009), who analyze graphically the relation between access prices and the development of alternative broadband infrastructures in Europe, and conclude that national regulatory authorities have adopted policies that are consistent with the ladder of investment approach.

  7. The entrant’s long-run level of experience could be equal to the incumbent’s level, in which case the entrant competes on a level-playing field with the incumbent (except for the access charge that it has to pay). It could also correspond to a lower or higher level of experience than that of the incumbent.

  8. For example, Cave (2006) argues that in the telecommunications industry, new entrants’ investments depend on their current revenues and/or their current customer base.

  9. Assuming that the acquisition of experience goes faster under facility-based competition, because for example the entrant controls its own infrastructure, would reinforce this asymmetry.

  10. Note that if the entrant always prefers service-based competition to facility-based competition, facility-based entry never occurs. Since we are interested in the date of facility-based entry, we do not consider this possibility.

  11. Assumption 2(iii) implies that the entrant’s incentive to switch from service-based to facility-based competition is higher in the long run than at the date of entry.

  12. In reality, entrants might incur positive entry costs. For example, in the telecommunications industry, with local loop unbundling, there are fixed costs due to co-location and order handling. However, these costs are negligible when compared to the cost of building a new infrastructure.

  13. For larger values of \(\underline{C}\), there might be equilibria where the entrant never rolls out its infrastructure. However, our focus is on how the timing of facility-based entry is affected by a phase of service-based competition and a process of market experience acquisition. We therefore assume that facility-based entry always occurs in equilibrium. Note also that in our setting an extremely late date of facility-based entry is equivalent to no facility-based entry.

  14. In our setting there is no commitment problem per se. Once the entrant has invested, there is no point for the regulator to renege on its commitment by setting a low access charge, because the entrant will always be better off using its own infrastructure. This is due to the fact that investment is zero/one in our setting and that there is only one entrant. As Avenali et al. (2010) show, a commitment issue would arise if we were considering a second entrant.

  15. We abstract from the optimal regulation of the access price, which would involve setting a more sophisticated access scheme, e.g. a time-dependent access price, as studied by Bourreau and Doğan (2006) or in our working paper version, Bourreau and Drouard (2010).

  16. Bourreau and Doğan (2005, 2006) study the incumbent’s reaction to the entry threat when it can set the access price to its infrastructure. See also Sect. 4 where we discuss to which extent the incumbent could influence the entrant’s acquisition of experience.

  17. For example, the regulator may have banned access.

  18. This is true if the investment cost is sufficiently convex. See Appendix 1.

  19. The process of experience acquisition has therefore no influence on the date of service-based entry. This result hinges in particular on our assumption that there is no fixed cost for service-based entry.

  20. This is true if the investment cost is sufficiently convex. See Appendix 2.

  21. See, for example, Gallini (1984); the incumbent firms reduce the entrants’ incentives to innovate by licensing their technologies. In the literature on access and investment, the existence of a replacement effect has already been pointed out by many studies (e.g., see Hori and Mizuno 2006; Vareda and Hoernig 2010; Bourreau and Doğan 2005, 2006).

  22. Note that the process of experience acquisition also affects investment incentives through current service-based competition profits, but that it is incorporated in the replacement effect, which depends on the current level of experience, \(\phi (T)\).

  23. See also our working paper version, Bourreau and Drouard (2010), where we discuss the optimal time-dependent access price in the present setting.

  24. The assumption of quantity competition seems reasonable to describe competition in telecommunications markets, where firms face capacity constraints. It has also been adopted by other authors, such as Foros (2004) and Nitsche and Wiethaus (2011).

  25. Since consumers make repeat purchases/subscriptions, there is always the same mass of potential consumers at each moment of time. This would not be true with the adoption of a durable good. The consumers who would purchase the durable good at a given period of time would exit the market, reducing the mass of potential adopters in subsequent periods. Additional effects would then arise, affecting the consumers’ decision of an adoption time. For example, to the extent that the quality of the good increases with the entrant’s experience, a consumer would have an incentive to wait for the entrant to become more experienced to purchase a higher quality durable good. We thank a referee for suggesting us this idea of future research.

  26. Consumers are also too small to influence the market outcome (e.g., the accumulation of experience).

  27. To understand how the game would be affected if firms were making dynamic quantity choices, first assume that the entrant is myopic, but that the incumbent is not. Since the incumbent takes the entrant’s current quantity as given when its sets its own quantity and the learning-by-doing process is only affected by firm E’s current production, the incumbent cannot influence the entrant’s process of experience acquisition through its quantity decision. Therefore, the two firms produce the short-run equilibrium quantities as if they were both myopic. Second, assume that the incumbent is myopic, but that the entrant is not. The entrant then internalizes the experience acquisition process in its quantity decision, and we have a learning-by-doing effect: the entrant produces a higher quantity, and since quantities are strategic substitutes, the incumbent produces less than in the short-run equilibrium.

  28. To extent that the incumbent prefers service-based competition over facility-based competition (because it earns wholesale profits under the former form of competition), it would have an incentive to slow down the entrant’s acquisition of experience to retard facility-based entry.

  29. This is done without loss of generality.

  30. To determine \(\phi _{F}^{a}\left( x,T,r\right) \), we use the fact that \(\phi ^{a}\left( x,T,r\right) \) is continuous at \(x=T.\)

  31. Note that \(\overline{x}\left( T,r\right) \ge T\), as \(\phi _{F}^{a}\left( x,T,r\right) \) is defined for \(x\ge T\). To simplify the exposition, we drop the arguments of \(\overline{x}\) in the rest of the text.

  32. This is true if \(C(\cdot )\) is sufficiently convex.

  33. Note that with another competition setting, this effect will also be present, but that it might go in the opposite direction, as \(\Delta \pi _{E}\) does not necessarily increase with \(\phi ^{a}\). For example, this is not true in the Hotelling setting that we developed in our working paper version, Bourreau and Drouard (2010).

  34. Note that this value of \(r\) does not necessarily correspond to the socially optimal \(r\).

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Acknowledgments

We thank Axel Gautier, Steffen Hoernig, Pınar Doğan and Wilfried Sand-Zantman for their useful remarks. We also thank audiences at the EARIE Conference (Ljubljana, Slovenia). Finally, we thank the Editor, Michael A. Crew, and two anonymous referees for valuable suggestions. Financial support from Orange is gratefully acknowledged.

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Authors and Affiliations

  1. Telecom ParisTech and CREST-LEI, Paris, France

    Marc Bourreau

  2. CREM, University of Rennes 1, Rennes, France

    Joeffrey Drouard

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  1. Marc Bourreau
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Correspondence to Marc Bourreau.

Appendix

Appendix

1.1 1. Second-order condition without access

Using (4), we find that

$$\begin{aligned} \frac{d^{2}\Pi _{E}^{na}}{dT^{2}}=\rho ^{2}e^{-\rho T}\int \limits _{0}^{\infty }e^{-\rho x}\pi _{E}^{F}\left( \phi \left( x\right) \right) \,dx-C^{\prime \prime }\left( T\right) \text {.} \end{aligned}$$

The firm term is positive or negative. Therefore, \(\Pi _{E}^{na}\) is concave if \(C\left( T\right) \) is sufficiently convex.

1.2 2. Second-order condition with access

Using (5), we find that

$$\begin{aligned} \frac{d^{2}\Pi _{E}^{a}}{dT^{2}}&= \rho e^{-\rho T}\left[ \pi _{E}^{F}\left( \phi \left( T\right) \right) -\pi _{E}^{S}\left( \phi \left( T\right) \!,r\right) \right] \\&\quad -\, e^{-\rho T}\phi ^{\prime }\left( T\right) \left[ \frac{ \partial \pi _{E}^{F}}{\partial \phi }\left( \phi \left( T\right) \right) - \frac{\partial \pi _{E}^{S}}{\partial \phi }\left( \phi \left( T\right) \!,r\right) \right] -C^{\prime \prime }\left( T\right) \text {.} \end{aligned}$$

The firm term is positive under Assumption 2(ii), whereas the second term can be either positive or negative. Therefore, \(\Pi _{E}^{a}\) is concave if \( C\left( T\right) \) is sufficiently convex.

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Bourreau, M., Drouard, J. Progressive entry and the incentives to invest in alternative infrastructures. J Regul Econ 45, 329–351 (2014). https://doi.org/10.1007/s11149-014-9248-9

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