Vertical Integration in Telecoms

Vertical Integration in Telecoms

Clementina Bruno (University of Piemonte Orientale and HERMES, Italy)
Copyright: © 2014 |Pages: 10
DOI: 10.4018/978-1-4666-5202-6.ch235

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Telecommunications belong to the broad category of the so-called network industries, a group of sectors including, for instance, water supply, gas, electricity, transportation, and presenting the common characteristic of relying on a network as a key asset. As for the other industries of the group, also for telecoms the ownership of the network, and the “last mile” especially, represents a powerful competitive advantage, as this kind of asset is so expensive to replicate that quite likely presents some “natural monopoly” features, while the downstream retail segment, that needs access to the local network in order to reach the final users, allows certainly for the presence of several competitors.

Usually the “last mile” belongs to the incumbent firms, which in general operate also in the retail segment. Although the regulators impose mandatory access to the last mile network (i.e. the incumbent must grant access to other firms under fair and equal condition at regulated prices), nevertheless incumbents have a strong incentive, and also the operational tools, to undertake anti-competitive discriminatory behaviors against the competitors. Discrimination can be price or non-price based. Price discrimination can, for instance, take the form of predatory prices in the retail market, subsidized (or “cross-subsidized”) by the margins recognized in the regulated wholesale segment; to prevent (or to detect) price discrimination, accounting separation, i.e. imposing just separated accounts for upstream and downstream units, is a sufficient tool (Cave, 2006). Non-price discrimination is also known as “sabotage,” and involves mainly quality difference in the intermediate input provision, i.e. the possibility that the incumbent does not provide access to competitors as timely and reliably than it does to its own downstream branch. As it is very difficult for regulators to verify such unfair strategies, a powerful “ex-ante” regulatory tool has been seen in functional separation. It is more pervasive than the “accounting” form, as the separated branches, still belonging to the same ownership, have not only to provide separated accounts, but also need to set-up separated compensation schemes for managers, and have some constraints in the circulation of employees and information.

Key Terms in this Chapter

Incumbent: It is the largest firm in an industry, or the firm which has been operating for the longest time. It usually enjoys some monopolistic power.

DEA: Data Envelopment Analysis. It is a non-parametric frontier technique based on linear programming that allows to compute the efficiency level of a given unit by comparing it with a frontier constructed by means of the best performing units in the sample (and their convex combinations). This method can be adapted to compute economies of scope.

Non-Price Discrimination: It has the same goals as price-discrimination, described below, but relies on non-price tools, for instance reducing the quality of the intermediate input supplied to competitors.

Price discrimination: Anticompetitive strategy that can be undertaken by an integrated incumbent in order to rise competitors cost and/or drive them out of the market. It relies on price instruments, such as predatory prices and cross-subsidization.

Accounting Separation: It is the softer separation form, that just requires to provide separate accounts.

Functional Separation: Establishment of independent units operating different activity branches. The separate entities belong to the same ownership, but provide separate accounts, have independent incentive schemes for managers, and face limitations in the circulation of employees and information. It is an “intermediate” regulatory measure, lying between the two extreme forms, accounting and ownership separation.

Ownership Separation: It is the most pervasive form of separation, that implies that the separate units do not belong to the same ownership.

Frontier Cost Function: It is a particular cost function that relaxes the cost minimization assumption, allowing the presence of some inefficiency, whose level differs across firms.

Economies of Scope: Cost savings associated to the joint provision of several outputs, with respect to their separate production by means of specialized firms.

Cost Function: It is a function that associates, to any given level of output and of input prices, the corresponding minimal production cost. In empirical applications, its parameters are usually estimated by means of econometric techniques.

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