Broadband and Structural Separation from the Perspective of Transaction Cost Economics

Broadband and Structural Separation from the Perspective of Transaction Cost Economics

Hidenori Fuke (Komazawa University, Japan)
DOI: 10.4018/978-1-60960-011-2.ch005
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Conduct regulation and structural separation are often discussed in industrial organisation studies as options to prevent the abuse of market power by vertically integrated firms toward the downstream market. Both the structural separation of NTT and conduct regulation have been discussed in the Japanese telecommunications industry since the introduction of competition in 1985 and the issue is still being discussed, although the industry is going through a transition from POTS (Plain Old Telephone Service) to the broadband internet. Past discussions have been inclined toward elimination of the harmful effects of vertical integration. However, there is a benefit of vertical integration in the sense that it will promote the efficient management of the firm concerned. I will present a new contention that it is important to conclude a balanced analysis of costs and benefits of vertical integration based on transaction cost theory. Structural separation in the broadband market entails significant transaction costs between a carrier with access facilities and firms offering broadband services by renting these facilities as input. These kinds of transaction costs are comparatively negligible in POTS. I will make it clear that the balance analysis of costs and benefits of structural separation has become more important in broadband than in POTS based on the actual differences in network structure.
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The reason why vertical integration has been discussed so much is explained by the probability that a vertically integrated firm might abuse market power it has built in the upstream market to the detriment of the downstream market. The abuse of market power derived from vertical integration typically includes ‘refusal to deal’ and ‘raising rivals’ costs’. If a firm having market power in the upstream market refuses to supply goods or services to rivals in the downstream market, they are obliged to exit from the market when they cannot find other sources of supply.

Price discrimination is also frequently discussed in this connection. A vertically integrated firm can raise wholesale prices for competitors in the downstream market. This kind of price discrimination drives competitors into disadvantageous situations. This is called ‘raising rivals’ costs’. Margin squeeze refers to the same kind of situation.

Two measures have been discussed to prevent these kinds of abuse of market power. One is conduct regulation to control the supply conditions of input goods or services, and the other is structural separation to divide a vertically integrated firm into a monopolistic input supplier and a final goods or services provider in the downstream market.

Although anti-competitive problems have been widely discussed, we must take into account the fact that vertical integration promotes efficiency1. The merits of vertical integration include the elimination of inefficiency between firms in addition to the usual economies of scale and scope.

A typical example is the elimination of the ‘hold-up’ problem. Investment into assets that have a value only in relation to a specific firm is called ‘asset specific investment’. Once a firm is committed to an asset specific investment, the counterpart might demand ex post unfavourable changes in the terms of the business or the termination of the business relationship. If a firm fears that it might fall into this kind of situation, it holds back from useful investment. Vertical integration will solve this kind of hold-up problem.

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