Barriers to Entry, Competition and Product Variety in European Residential Internet Markets
Posted: 30 Mar 2013
Date Written: March 28, 2013
A fundamental policy in the European regulatory framework has been the unbundled access to the local loop of the fixed incumbent operator. European legislation regarding local loop unbundling (LLU) was introduced in 2000 before the adoption of the New Regulatory Framework in 2002. Hence, competition between Internet Service Providers (ISPs) in Europe has been developed by providing DSL services from the incumbent operator’s infrastructure. LLU refers to various regulatory offers ranging from full unbundling to line sharing or resale and has been diversely implemented in European countries. The motivation behind such a decision was to favor service-based over facilities-based competition with LLU viewed as an effective way to deal with network monopolies and to promote competition and consumer choice in broadband markets. Interestingly, despite a decade since the implementation of unbundling in Europe, most of the economic literature has concentrated on how unbundling affects the entry and infrastructure investment decisions of ISPs. Broadband competition can also be reflected in the variety of Internet plans provided to end-users. This paper uses theory and data to examine how firms compete in the variety of Internet plans offered to residential consumers in European Internet markets.
The theory considers a two-tier industry in which an upstream network operator sells local loop access to ISPs through a linear access price. ISPs compete by setting quantities and offering different Internet products to end-users. All products, both within and outside the firm, are assumed to be imperfect substitutes. The total cost for an ISP comprises a fixed production cost, a fixed cost per variety and a marginal cost including the unit access price to the local loop. Interactions between ISPs are modeled as a two-stage game. In stage one, each ISP decides to enter the market and market structure is endogenously determined. In stage two, each ISP decides on the number of varieties it will produce and sets the quantities of each variety it offers to end-users. We proceed by backward induction and then derive the subgame perfect Nash equilibrium of the game. Assuming the access price can act as a barrier to entry, comparative static results show how the access price impacts the number of Internet products offered by each ISP and the market structure in the long-run equilibrium.
Comparative static predictions are tested with an empirical model that relates product variety to barriers to entry and cost and demand controls. The model is estimated on biannual data from ISPs in fifteen European markets from 2004 to 2012. Variety is measured by the number of plans offered by the ISP, the number of bit-capped plans offered, the number of technologies used, and by the range of upload speeds offered. Barriers to entry are measured by a qualitative variable that equals one when the country permits unbundling and zero otherwise, the number of years since the country permitted unbundling, the number of unbundled local loops in the country, and the maximum price a new entrant has to pay for access to an unbundled local loop in each country. Cost and demand controls are measured by the country’s gross domestic product, population, geographical area, number of main telephone lines and country and time fixed effects. By estimating the model, we can see whether, conditional on cost and demand conditions, there is a systematic relationship between Internet product variety and the relaxation of barriers to entry in European markets through LLU.
Keywords: Product variety, Barriers to entry, Broadband, Internet
JEL Classification: L1, L5
Suggested Citation: Suggested Citation