oxera response to berec questions on oligopoly analysis and regulation · oxera response to berec...

Oxera response to BEREC questions on oligopoly analysis and regulation

Independent Oxera response

Non-confidential

25 January 2015

www.oxera.com

BoR PC01 (15) 17

Oxera Consulting LLP is a limited liability partnership registered in England No. OC392464, registered office: Park Central, 40/41 Park End Street, Oxford, OX1 1JD, UK. The Brussels office, trading as Oxera Brussels, is registered in Belgium, SETR Oxera Consulting Limited 0883 432 547, registered office: Stephanie Square Centre, Avenue Louise 65, Box 11, 1050 Brussels, Belgium. Oxera Consulting GmbH is registered in Germany, no. HRB 148781 B (Local Court of Charlottenburg), registered office: Torstraße 138, Berlin 10119, Germany.

Although every effort has been made to ensure the accuracy of the material and the integrity of the analysis presented herein, the Company accepts no liability for any actions taken on the basis of its contents.

No Oxera entity is either authorised or regulated by the Financial Conduct Authority or the Prudential Regulation Authority. Anyone considering a specific investment should consult their own broker or other investment adviser. We accept no liability for any specific investment decision, which must be at the investor’s own risk.

© Oxera 2015. All rights reserved. Except for the quotation of short passages for the purposes of criticism or review, no part may be used or reproduced without permission.

Oxera response to BEREC questions on oligopoly analysis and regulation

Oxera

Contents

1 Introduction 1

2 Oligopolistic competition in electronic communications 2

2.1 Industry characteristics and evolution 2

2.2 Cross-sector convergence, separation of service and physical layers, and OTTs 2

2.3 Vertical relationships and the internet value chain 2

3 Possible effects of oligopolistic competition 4

3.1 The range of oligopolistic outcomes 4

3.2 The costs and benefits of oligopolistic completion 5

4 Regulating oligopolies 7

4.1 Ex ante regulation not required in some cases 7

4.2 Ex ante regulation of oligopolies with high likelihood of tacit collusion 7

4.3 Ex ante regulation of oligopolies with low likelihood of tacit collusion 9

5 Remedies in the context of oligopolies and other issues 11

5.1 Remedies in the context of oligopolies 11

5.2 Other issues 11

Oxera response to BEREC questions on oligopoly analysis and regulation Oxera

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1 Introduction

Oxera welcomes the opportunity to respond to the ‘BEREC Report on Oligopoly analysis and regulation - Questions to stakeholders’ published in December 2014.1

Oxera advises companies, policymakers, regulators and lawyers on any economic issue connected with competition, finance or regulation. We have been doing this for more than three decades, and have advised telecoms regulators (for example, OPTA, ComReg, and Ofcom), the European Commission, and operators (for example, BT, Liberty Global, FastWeb, and Vodafone) across many member states including the UK, the Netherlands, Belgium, and Spain. As professional economic practitioners, Oxera advises on the application of regulatory and competition guidelines, such as these being developed by BEREC, to real-world markets. More information about Oxera is available on our website (www.oxera.com).

Drawing on this experience, our independent response sets out questions and issues that could facilitate the analysis, and practical application, of any proposed ex ante regulation of oligopolies in the electronic communications sector.

Oxera’s comments in this response are not exhaustive or conclusive. Rather, our aim is to highlight possible considerations for debate as part of BEREC’s work on oligopoly analysis and regulation.

Our response follows the order of the questions raised by BEREC in its questionnaire:

section 2 discusses oligopolistic competition in electronic communications markets;

section 3 analyses the possible effects (costs and benefits) of oligopolies based on a discussion of the range of oligopolistic outcomes;

section 4 considers the case for regulating oligopolies;

section 5 comments on remedies in the context of oligopolies and other issues.

This response does not contain any confidential information.

Contact details

Any questions relating to this Oxera response should be addressed to:

Sumit Sharma Senior Consultant

Email: [email protected] Tel: +44 (0) 20 7776 6615

Oxera 200 Aldersgate 14th Floor London EC1A 4HD UK

1 BoR (14) 172.

http://www.oxera.com/

mailto:[email protected]


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2 Oligopolistic competition in electronic communications

2.1 Industry characteristics and evolution

An important characteristic of electronic communications networks (both fixed and mobile) is the presence of substantial fixed costs which leads to economies of scale—i.e. increasing traffic volumes tend to decrease the average cost per unit of traffic carried over the network. This means that only a small number of networks (or even a single fixed network) may be able to operate at a profitable or cost-minimising level of production in the market. In addition, there may be technical or resource limits, such as the limited availability of suitable radio spectrum for mobile networks.

Thus the electronic communications sector is naturally characterised by oligopolies or even fixed network monopolies in some cases. However, as we discuss next, the sector is evolving, and technological developments mean that there may be more than one fixed network serving end-users, at least in some areas where CATV networks are present and/or alternative operators have rolled out networks.

2.2 Cross-sector convergence, separation of service and physical layers, and OTTs

A number of factors are driving cross-sector convergence (and consolidation) in the electronic communications sector. These include convergence of previously disparate network technologies, increasing consumer demand for service bundles and data, and competition to provide these services.

The convergence of network technologies is based on the adoption of Internet Protocol (IP) technology which can transport different traffic types such as voice, various instant messaging services (which are essentially data traffic), and video in addition to data used for Internet services.2 The adoption of IP has meant that CATV and fixed line operators compete with each other (whereas previously they did not) and that fixed and mobile networks are converging.3 Today the same or similar services are provided over all these networks.4

The move to IP also means that the supply of services and content is separated from the underlying physical network. This allows OTT service providers to compete with both fixed and mobile network operators.

2.3 Vertical relationships and the Internet value chain

Following these developments, end-user demand for access to communications networks is ‘derived’—i.e. based on the demand for various services (voice, messaging, and video/media) provided over these networks, rather than the networks themselves. The supply of these end-user services is made possible via vertical relationships between network operators and various content and

2 For example, to transmit voice, VoIP can be used over fixed networks and VoLTE over mobile LTE networks. IP-based video on demand (VoD) is an over the top (OTT) service—i.e. provided over the Internet—and IPTV is a specialised service usually provided over reserved broadband capacity so as to meet certain quality of service parameters. 3 An integrated network operator can also exploit network scale and scope economies by jointly supplying fixed and mobile services. For example, an integrated network could share network components such as backhaul links and the core network. There are also likely to be economies of scale and scope in retail activities such as common billing systems, customer care centres, and joint marketing campaigns. 4 In some member states, alternative operators and utility companies (water and electricity companies) have rolled out fibre networks in some areas. These networks also compete with the incumbent operators’ networks.


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service providers. These include TV broadcasters, OTT companies such as ‘Netflix’, and Internet companies such as ‘Google’.

For example, there are at least three distinct layers in the electronic communications services’ supply chain (with strong interdependencies at each layer) which enable the supply of media services. At one end (closest to the consumer) lies the network (or platform) operator. These operators rely on channels provided by content aggregators (or broadcasters) to provide media services, while the aggregators rely on network operators to gain reach to drive advertising income. In turn, aggregators rely on a supply of compelling content from content producers in order to gain prominence with the network operators and/or paying subscribers and advertisers. At the same time, content producers need a wide distribution by a well-regarded broadcaster to gain exposure and drive after-sales.

Any analyses of the effects of oligopolistic competition and proposed ex ante regulation should take account of the characteristics of electronic communications networks and the associated services, and the technological and market developments (which will vary across member states).


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3 Possible effects of oligopolistic competition

3.1 The range of oligopolistic outcomes

We note that the outcome of oligopolistic competition can be the same as that of a competitive market, somewhere between a competitive outcome and monopoly, or the same as a monopoly. For example:

1. a homogeneous goods Bertrand model in which firms compete on price is an oligopoly with a competitive outcome. This assumes that there is no collusion among firms (or there is low likelihood of tacit collusion);

2. a homogeneous goods Cournot model in which firms compete on capacity; a heterogeneous good Bertrand model; or a dynamic model in which firms compete on both price and capacity are some examples of oligopolies with an outcome somewhere between a competitive and monopoly outcome. This also assumes that there is no collusion among firms (or there is low likelihood of tacit collusion);

3. an oligopoly in which firms collude (either explicitly or tacitly or there is high likelihood of tacit collusion) and act as a monopoly is likely to result in a monopoly outcome, depending on how successful the firms’ collusive strategy is.

It is clear that no regulatory intervention is required in the first case above—i.e. when the outcome of an oligopoly is the same as a competitive market. It is also well understood that in the third case above, a collusive oligopoly (or an oligopoly with high likelihood of tacit collusion) will lead to market outcomes that are likely to reduce consumer and social welfare, and that some form of intervention (ex ante or ex post) may be required.

The case for regulatory intervention in the second case above (an oligopoly with low likelihood of tacit collusion and an outcome somewhere between a competitive and monopoly outcome) is not obvious. Any such intervention will have to carefully balance:

the relative costs, as firms exploit their market power. These costs will depend on how ‘far away’ the oligopoly outcome is from the ‘competitive’ outcome. A competitive outcome in electronic communications markets may be defined in terms of policy goals such as to ensure that the market works to maximise consumer welfare in the short and long run. There may be a trade-off between short- and long-run consumer welfare reflecting the trade-off between economies of scale and the number of suppliers, and the degree of product differentiation, as discussed below;

the potential loss of concrete benefits of an oligopoly such as increased investment incentives and improved quality that may result from the proposed regulation, as discussed below;

the administrative and efficiency costs of the intervention. For example, the costs of implementing, reporting, and monitoring rules for multiple operators; and potential distortion of free market competition.

Thus it is important to develop clear guidance on the specific form that a problematic (as opposed to benign) oligopoly would take and hence warrant further investigation.


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3.2 The costs and benefits of oligopolistic completion

While, in economic theory, oligopolistic markets can lead to a higher price and/or reduced output compared with a ‘competitive’ market, there is a trade-off between economies of scale and the number of suppliers of electronic communications networks. Additional firms may increase or decrease overall welfare.5

In an electronic communications industry characterised by imperfect competition (i.e. a few service providers, each exercising some market power) and scale economies, entry is likely to lead to lower volumes for each service provider. This means that there is a trade-off between the benefits derived from more competition—introduced by additional network operators—and the exploitation of scale economies. Allowing additional network operators into the market can lead to a reduction in the exercise of market power, but it might also mean higher average costs for all operators as scale economies are not fully exploited.

On the other hand, if output per firm is at a level that allows significant scale economies to be exploited, there are a variety of benefits—for example:

lower industry average and marginal costs which may be passed on to end-users (in the form of lower prices or higher quality) if there is sufficient competition;

if operations are profitable, network operators will have incentives to invest in expanding their networks, introducing new technologies and delivering better-quality services.

We also note that it is not clear that a standard Cournot model of oligopoly would apply to the electronic communications industry which is characterised by high sunk investment costs, substantial excess capacity, and negligible marginal costs of production. Given these characteristics, oligopolistic competition in the electronic communications sector may be closer to Bertrand (price-based), and therefore a competitive outcome, than Cournot (capacity-based) competition.

This raises the question ‘is two enough’ to arrive at a long-term competitive outcome in these markets? In this context we note that the focus of any analysis should not only be on relatively higher prices in an oligopoly (compared with some ideal competitive structure) because this ignores:

potential changes/innovations in services offered as a result of investment in new technologies and demand trends. For example, price indices may fail to reflect the take-up of data-driven plans compared with minute-driven plans;

quality of service and benefits from competition on non-price attributes, which include broadband speed, reliability, security and privacy; customer service differentiators, such as access to technical support and installation professionals; innovative media services, such as on-demand catalogues or highest-quality broadcasts; as well as other initiatives such as WiFi hotspots and international roaming agreements.

With product differentiation, we note that new entrants may increase welfare by introducing new product varieties. This may counter some of the welfare-reducing negative scale economies effect (where entry is likely to lead to lower volumes for each service provider). However, product differentiation is

5 See for example, Church, J., and R. Ware (2000), Industrial Organisation, A Strategic Approach, Irwin McGraw-Hill, 249–56; Mankiw, G.W. and M.D. Whinston (1986), ‘Free entry and social inefficiency’, Rand Journal of Economics, 17:1.


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increasingly based on the set of services provided over electronic communications networks, not the physical networks themselves, as broadband (Internet) access is increasingly commoditised.

Thus, the key question that should be analysed is the following: what consumer benefits (in the short and long run) are new network providers (as opposed to new service providers) likely to generate?

In other words, how ‘far away’ is the oligopoly from achieving the right balance between innovation, investment, affordable prices, and consumer choice?

In doing so, it is important to offer guidance on how best to capture the non-price aspects of network competition, for measurement and inclusion in the regulatory analysis of oligopolies.


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4 Regulating oligopolies

4.1 Ex ante regulation not required in some cases

As noted above, the outcome of oligopolistic competition can be the same as a competitive market, somewhere between a competitive outcome and monopoly, or the same as a monopoly. Ex ante regulation would not be appropriate in the following two cases:

the outcome of an oligopoly is the same or similar to a competitive market—i.e. it achieves the right balance between innovation, investment, affordable prices, and consumer choice. In addition, there is no collusion among firms (or there is low likelihood of tacit collusion);

explicit collusion (or cartelisation), as this is already covered by Article 101 TFEU.

Next we discuss the case for ex ante regulation for oligopolies with a high likelihood of tacit collusion (section 4.2) and for oligopolies with a low likelihood of tacit collusion (section 4.3).

4.2 The case for ex ante regulation of oligopolies with high likelihood of tacit collusion

There may be a role for ex ante regulation if network operators have the incentive and ability to collude tacitly, and this (potential) abuse cannot be addressed using competition law.

There are established economic criteria to assess the existence or likelihood of tacit collusion—for example, as set out in the EU Horizontal Merger Guidelines.6 The criteria relate to the incentives and ability to collude, including factors such as transparency, stability of the market, disciplining mechanisms, and external competitive pressure. The need for ex ante regulation should be based on an analysis of these criteria.

However, we note that ongoing market developments mean that the electronic communications market is in a continuous state of flux. As noted earlier, these developments include the increasing popularity of bundles (for example, quad-play offers with mobile) and the entry of OTT service providers. These developments and other asymmetries between network operators (such as technology and investment costs) provide incentives for network operators in an oligopoly to compete aggressively and to continue investing to improve their services.

We discuss some of these developments in greater detail next.

4.2.1 The popularity of bundles

As retail broadband is increasingly supplied as one part of numerous different bundle offers, assessing ‘the price’ of the broadband offered in a dual-, triple- or even quad-play bundle is not straightforward; more so, given the large number of variations possible with respect to the other bundle elements. This complicated retail structure obfuscates the market, makes tacit collusion less likely. This is because price transparency is a crucial aspect of coordination. If prices are unobserved (or, as in this case, suitably obfuscated, with operators unable to observe which particular package a consumer switches to), a firm losing sales and observing churn rates cannot determine why this is happening—an

6 Official Journal (2004/C 31/03).


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unexpected change in demand, or a deviation from the coordinated outcome by the other parties. In such a case, it can be expected that a punishment strategy will be erroneously employed in instances of naturally decreasing demand, destabilising the coordination.

In addition, although the churn rate may be observable, it would be an insufficient instrument to monitor a coordinated outcome for deviations. This is because there is no single, simple measure of churn to easily monitor. Rather, churn can differ between product categories (e.g. individual TV/voice/broadband service, double-play bundles, triple-play bundles), subscriber types (e.g. low-/high-value subscribers), etc. This variety of churn parameters makes identifying churn as a result of competitor actions substantially more difficult.

4.2.2 Evolving customer demand and dynamism introduced by OTTs

An important spur to technical development comes from retail market developments and evolving consumer demands. As discussed above, consumers increasingly buy broadband services in bundles which include other services such as media and voice. These services add value to a broadband access connection and may be supplied by various OTT service providers in addition to traditional telecoms or CATV operators.

At the same time, consumer demand for higher broadband access speeds is increasing. This demand for ever-increasing Internet bandwidth is a derived demand stemming from wide-reaching changes in the communications and entertainment technologies that consumers use. For example, VOIP and video-conference technologies, OTT video and music streaming, and online gaming all require significant amounts of bandwidth. As consumers continue to adopt these services in multi-device households, network operators will come under increasing consumer pressure to deliver service upgrades in support of this usage.

OTT services are also an emerging challenge for network operators, offering innovative services on the supply side and altering consumer habits on the demand side. With the continued expansion of broadband Internet, a number of high-profile OTT services have recently entered the media market, and increasingly impose competitive constraints. Examples of such OTT services include ‘Netflix’ and ‘Amazon Prime’ as well as OTT services launched by traditional broadcasters such as ‘HBO’. Similarly, OTT providers are active in the provision of voice services.

We note that the competitive pressure from OTT service providers on each network operator is independent of the presence of other network operators. From an economic perspective, these new services contribute to enhanced and more uncertain dynamics in the market, albeit these dynamics and the competitive constraint imposed by OTTs will vary across member states.

These changes in the way that communications services are consumed, together with evolving customer demand (for service bundles and higher speeds) adds instability to the market and may be an important driver of network operators’ quality and service upgrades.

4.2.3 Asymmetries in technology and investment costs

Asymmetry in investment costs and technology development cycles may also mean that the opportunity to gain a technical advantage through network upgrades is likely to come at different times for CATV, fixed and mobile


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operators. This also reduces the likelihood of tacit collusion among different network operators. Again the situation will vary across member states.

For example, consider a CATV and PSTN operator that work with technically dissimilar systems and, as a result, face substantially different cost profiles. A DOCSIS 3.1 upgrade to provide faster broadband access should cost less than the fibre roll-out by a traditional PSTN operator.7 In addition, the dynamic nature of these technical dissimilarities means that the opportunity to gain a technical advantage through network upgrades will come at different times for different networks. This allows each network technology in turn to enjoy a period of quality leadership, before another technology catches up and exceeds the new standard. This dynamic can be expected to incentivise network operators to capitalise on their position of quality leadership while it lasts, by aggressively attracting subscribers. This should increase profits and help with the recovery of (often substantial) upgrade investment costs.

This dynamic may create further instability for any hypothetical coordination among firms.

Thus, an ex ante intervention in the market should be:

supported by robust economic evidence that, absent the regulation, tacit coordination is likely to occur;

based on identifying specific reason(s) why tacit coordination is likely to occur and persist. This should help to design and target remedies to alleviate the problem(s) identified, while also preventing unnecessarily burdensome regulation from reducing the benefits that an oligopolistic market structure can provide;

assessed on a case-by-case basis, given the diversity of market structures and the regulatory context across member states.

4.3 Ex ante regulation of oligopolies with low likelihood of tacit collusion

As discussed in section 3.2, it is important to develop clear guidance on what is the ‘competitive’ outcome against which a ‘problematic’ (as opposed to benign) oligopoly is compared. This is important to estimate the relative costs imposed by an oligopoly.

Only if these costs are greater than the benefits and the administrative and efficiency costs of regulation would it be reasonable to regulate an oligopoly with low likelihood of tacit collusion.

However, estimating the relative costs and benefits of an oligopoly is not a trivial exercise, given the increasingly complex set of interactions in the electronic communications market, including the various vertical relationships discussed in section 2.3.

7 This is because the implementation of DOCSIS 3.1 requires the replacement of certain active equipment only, and the reclaiming of bandwidth currently used for analogue signals to offer speeds in excess of 200mbps. (Speed tests by Virgin Media, reported by ISPreview at: http://www.ispreview.co.uk/index.php/2014/07/virgin-media-uk-lab-testing-10gbps-docsis-3-1-broadband-upgrade.html, accessed 9 December 2014.) This upgrade also benefits from backward compatibility, reducing the need for, and cost of, upgrades to customer premises equipment (CPE). In contrast, to reach speeds of this magnitude with existing technologies, a PSTN operator will need to roll out a fibre network, which is both time-consuming and relatively more costly.

http://www.ispreview.co.uk/index.php/2014/07/virgin-media-uk-lab-testing-10gbps-docsis-3-1-broadband-upgrade.html

http://www.ispreview.co.uk/index.php/2014/07/virgin-media-uk-lab-testing-10gbps-docsis-3-1-broadband-upgrade.html


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In particular we note the following.

Any regulation of oligopolies in the electronic communications sector should take a holistic approach across the Internet and media value chain. This is because two-sided (or multi-sided) vertical relationships among platform operators and various content and service providers are likely to have important effects on the market power of platform operators.

The increasing vertical integration between network operators, content providers and content producers also adds an interesting dynamic to the assessment of oligopolistic outcomes in these markets, and should be taken into account. On the one hand, such vertical integration reduces the double (or even triple) marginalisation that occurs in multi-level supply chains. It may also increase coordination between market participants that can lead to faster advances as new technologies introduced at one level are adopted as a ‘test case’ by the vertically integrated firm’s own up/downstream suppliers. Thus, consumers may benefit from such vertical integration.

On the other hand, vertical integration may lead to input and/or market foreclosure, which may reduce competition and harm consumer welfare.

In addition, any ex ante regulation of oligopolies should:

identify the main source of network operators’ retail market power. This should help to design and target remedies to alleviate the problem(s) identified, while also preventing unnecessarily burdensome regulation from reducing the benefits that an oligopolistic structure can provide;

consider how other regulations, such as mandating ‘net neutrality’, may constrain network operators’ market power;

identify the main driver of competition among network (infrastructure) operators and consider the incentives to offer commercial wholesale access and its possible role in promoting competition.

We note that these are some of the factors that should be considered when proposing to regulate oligopolies, and emphasise again that this is not an exhaustive list.

Given the complex interdependencies in the electronic communications market and diversity of market structures and regulatory context across Member States, a careful case-by-case examination should be undertaken to ensure that the full competitive effects of any resulting oligopoly structure are considered.


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5 Remedies in the context of oligopolies and other issues

5.1 Remedies in the context of oligopolies

Any remedies imposed in the context of oligopolies should reflect the specific problems identified in the relevant markets which make the oligopolistic outcome deviate from the policy goals such as maximising short- and long-run consumer welfare.

Moreover, regulatory guidance should ensure that the various benefits of oligopolies are also taken into account. This could, for example, include a consideration of the longer horizon of competition (due to technological development), providing solutions that ensure continued competitive interaction until market developments can once again take over, but that do not extend beyond the period required.

5.2 Other issues

Some other important issues include the appropriate standard of proof to meet in order to justify an ex ante intervention in oligopolistic markets, as well as the time period that any intervention should last given the dynamic nature of the electronic communications market.

Email: [email protected] www.oxera.com Oxford Park Central 40/41 Park End Street Oxford OX1 1JD United Kingdom Berlin Pariser Platz 4a 10117 Berlin Germany Brussels Stephanie Square Centre Avenue Louise 65 Box 11 1050 Brussels Belgium London 200 Aldersgate 14th Floor London EC1A 4HD United Kingdom

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