The Potential for Competition in Network Communications Industries

Abstract

Is monopoly the inevitable market outcome for a network industry without regulation? Policy related to network communications industries historically has been based on the assumption that the characteristics of these industries will lead to high concentration, and ultimately monopoly. However, current economic theory and empirical evidence is insufficient to determine the industry structure of these markets without regulation. This paper provides a formal framework - The Network Pricing Game - to identify when competition between communications networks is a sustainable market outcome. The Network Pricing Game is a stylized model developed in this paper to reflect the characteristics of communications networks, namely significant fixed costs and friction in switching for subscribers, and to focus on a competing network firm's exit decision. The results of The Network Pricing Game show that the sustainability of competition between networks is influenced by initial market share allocations, propensity of subscribers to switch networks, fixed costs of operations, a market's monopoly price and marginal cost. These results are used to explain observed market structure in different network communications markets, namely local telephone and broadband Internet access.

The analysis in this paper shows that monopoly is the inevitable market outcome in some network communications markets, but not all. An important implication of the Network Pricing Game results is that policy must be designed to meet market conditions. In some markets, competition will result without regulation. In other markets, where competition is not sustainable, policymakers may choose to promote competition through regulatory intervention, thereby preventing monopoly where it is the inevitable market outcome. In particular, the relationship of initial disparity in market shares to the potential for competition found in this paper makes the timing of intervention critical. In some markets where monopoly is inevitable in the mature market, earlier-stage regulatory intervention may prevent this "inevitable" monopoly.

Keywords: Network Competition, Pricing, Telephone, Asymmetric Competition, Exit, Pricing Game

JEL Classification: C72, D43, L11, L13, L96