Fiber to the Premise (FTTP) Industry Structure: Implications of a Wholesale-Retail Split

Abstract

In some communities, we observe a single vertically integrated FTTP network owner and service provider that can either be profit maximizing or welfare maximizing. In other cases, either out of choice or regulation, we observe the network owner (the wholesaler) leasing facilities to competing service providers (retailers), who then provide voice, video and data service over the shared network (wholesale-retail split). The network owner can either wholesale dark fiber or “lit” transport (and can be profit maximizing or welfare maximizing). In this paper, using a simplified model where subscribers always buy voice service and choose between either broadband data service or video service or the video and data bundle, we show that such a wholesale-retail split interferes with the ability of the network owner to price discriminate. We conclude that for a bivariate correlated normal distribution of willingness to pay for data and video services, the supply side economics of FTTP (i.e., the fact that the marginal cost of provisioning the bundle is less than the sum of the marginal costs of provisioning the individual services) ensures that the bulk of the extractable economic surplus resides in the bundle and not in the individual services. Since the wholesale-retail split interferes with wholesaler’s ability to extract economic surplus only from an individual service (video service) and not from the bundle, the implications (the difference between the profits of a profit maximizing wholesaler and a profit maximizing vertically integrated entity) are modest, at best. Our analysis also shows that municipalities or communities that build out FTTP and choose to be wholesalers (i) can realize sustainable prices, (ii) are likely to create greater welfare and (iii) are just as likely to recover costs (vis-à-vis vertically integrated entities).