Dropping the Bundle? Welfare Effects of Content and Internet

13 Pages Posted: 30 Mar 2017 Last revised: 16 Aug 2017

Date Written: March 30, 2017

Abstract

Bundling of broadband access with other services has been a defining characteristic of internet access markets for as long as broadband technologies have been available. Initially, cable television competitors entered telecommunications markets by bundling first voice telephony, and subsequently (broadband) internet access with their television products. Telecommunications firms rapidly followed suit by reselling access to pay television (either via third-party infrastructures or their own), leading to the ubiquitous ‘triple play’ offering coming to dominate residential market purchase. Initially, such bundling likely led to higher levels of broadband uptake than would have occurred under mandatory unbundling, as those with low willingness-to-pay for broadband but higher willingness-to-pay for the other products (i.e. negative correlation) might buy broadband in a bundle, but not at stand-alone prices (Heatley & Howell, 2010).

From the outset, concerns have been voiced that bundling access to content (television) and infrastructure (broadband) by a telecommunications provider with market power could result in foreclosure of competition in content (television) markets (e.g. Papandrea, Stoeckl & Daly, 2003; Krämer, 2009; Maruyama & Minamikawa, 2008). Such fears led to mandatory separation of cable television and telecommunications providers in Australia, and some other OECD countries (OECD, 2000) and is a recurring theme of political discussion around the topic.

Theoretical models, however, suggest that even though such foreclosure may occur under some circumstances, under others bundling may yield both higher profits and higher total surplus than mandatory unbundling (à la carte sales). These include products with very low marginal costs (Bakos & Brynjolfsson, 1999) and that are nonrivalrous in consumption (Liebowitz & Margolis, 2008), certain relative demand elasticities for the products in the bundle (Papandrea, Stoeckl & Daly, 2003) and where economies of scope increase consumer surplus (Arlandis, 2008). Indeed, regulations to cap market share or impose à la carte on cable operators may reduce total surplus, and absent offsetting increases in consumer welfare, such policy measures may reduce total welfare (Adilov, Alexander & Cunningham, 2012).

Despite highly-nuanced circumstances influencing the welfare effects of bundling internet content with internet access, the potential to reduce competition by offering premium content with broadband access poses questions about the potential substantial lessening of competition in mergers such as that proposed between AT&T and Time-Warner. The bundling of broadband and premium content in particular may increase the risk of foreclosure, but focusing unduly on the supply-side arguably risks giving too little weight to the interplay between consumer-specific factors on the demand side (Howell & Potgieter, 2016). This risk is exacerbated by the paucity of empirical evidence to inform decision-making. Theoretical models provide some insights, but are limited by their stylized assumptions, which do not necessarily map neatly to the actual decisions made by participants in the relevant exchanges. Simulation analysis, however, offers insights to inform such complex merger decisions, as the scenarios examined can take account of the multiple nuances in both observed and hypothesized demand-side interactions.

To this end, we apply simulation analyses to investigate the situation where a basic content package, a premium content package and broadband are offered by a firm and analyze the firm's price-setting behavior when customers react to a given set of prices by maximizing their individual consumer surplus.

The model:

The model assumes that there are consumers, each with a known a priori willingness-to-pay (WTP) for a basic content package, a premium content package and unbundled broadband respectively. Each customer then has an imputed willingness to pay for the four bundles under consideration: basic plus premium content (index 2), basic content plus broadband (index 4), premium content plus broadband (index 5) and basic as well as premium content plus broadband (index 6).

Given a tuple of prices chosen by the monopoly provider of the services, each customer selects which (if any) of the products or product bundles to purchase to maximize its consumer surplus well as possible restrictions imposed by a regulator. The producer chooses prices so as to maximize its revenue. For information goods this can be treated as identical to the profit of the producer.

We randomly assigned for each consumer. WTP values and prices are assumed to be integers and prices set by the producer. This calculation requires a very large number of iterations and considerable computing resources.

The analysis and implications:

We analyze a large number of instances of the problem, subject to assumptions about the WTP distributions that, in our view, are realistic in order to characterize the market outcomes and to indicate where and how often regulatory intervention will positively affect total (respectively, consumer) welfare. Early indications are that welfare is often maximized when a triple play bundle can be offered. Furthermore determining where social welfare is maximal depends in a complex way on the underlying willingness to pay of heterogeneous groups of customers. The implications for merger investigations are discussed.

References

Adilov, N., Alexander, P., & Cunningham, B. (2012). Smaller pie, larger slice: how bargaining power affects the decision to bundle. The B.E. Journal of Economic Analysis and Policy 12(1), Article 12.

Arlandis, A. (2008). Bundling and economies of scope. Communications and Strategies Special Issue, November 2008, 117-129.

Bakos, Y., & Brynjolfsson, E. (1999). Bundling information goods. Management Science 45(12), 1613-1630.

Heatley, D., & Howell, B. (2009). The brand is the bundle: strategies for the mobile ecosystem. Communications and Strategies 75, 79-100.

Howell, B., & Potgieter, P. (2016). Submission on Letter of Unresolved Issues. http://www.comcom.govt.nz/dmsdocument/14963

Krämer, J. (2009). Bundling vertically differentiated communications services to leverage market power. Info 11(3), 64 – 74.

Leibowitz, S., & Margolis, S. (2008). Bundles of joy: the ubiquity and efficiency of bundles in new technology markets. Journal of Competition Law & Economics 5(1), 1–47.

Maruyama, M., & Minamikawa, K. (2009). Vertical integration, bundling and discounts. Information Economics and Policy 21 62–71.

Papandrea, F., Stoeckl, N. & Daly, A. (2003). Bundling in the Australian telecommunications industry. The Australian Economic Review 36(1), 41-54.

Keywords: Competition, Agglomeration effects, Media mergers, Broadband infrastructure, Content networks

JEL Classification: L96, D40, C63

Suggested Citation

Potgieter, Petrus H and Howell, Bronwyn E., Dropping the Bundle? Welfare Effects of Content and Internet (March 30, 2017). Available at SSRN: https://ssrn.com/abstract=2943283

Petrus H Potgieter (Contact Author)

University of South Africa ( email )

P.O. Box 392
UNISA
Pretoria, Gauteng 0003
South Africa
+27 12 433 4622 (Phone)

No contact information is available for Bronwyn E. Howell

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