de fontenay & liebenau nov. 2005 1 scale & scope in the telecommunications industry:...

de Fontenay & Liebenau Nov. 2005

1

Scale & Scope in the Telecommunications Industry:

Implications for innovation & competition

Alain Bourdeau de FontenayQueen’s College, CUNY & Columbia University

Jonathan LiebenauLondon School of Economics & Columbia University

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AgendaProblem: Views of scale & scope & Policy effects

Transition of industryAlternative modelsFramework Dynamic markets “Network of networks”

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Problem

Incumbents’ legacy structureTechnology becomes entry barriersUnable to respond to market signals Unable to invest efficiently Unsustainable competitive advantage

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Problem

Distort markets due to: Sunk network plus Misguided assumptions

New entrants Bankrupted, despite being More efficient

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Problem

No evidence incumbent more efficientEntrant difficulties falsely assumed to be: Inability to compete Scale & scope of incumbent

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Tautology

Technologies designed & adopted To the market structure Constitute conscious choices Not market efficiencies

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Tautology

Technologies designed & adoptedIncumbent (monopoly) No need to respond to market forces Could adopt network designs & develop

technology that furthered its mandate on other bases.

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Legacy technology

Observing legacy monopoly technology

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Legacy technology

Monopoly technologyNot “efficient” in a economic or social welfare sense

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Legacy technology

Monopoly technologyNot “efficient” Demonstration of scale & scope Not connected to efficiency Within the “sunk” network

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Transition of industry

Coevolution of: Technology Markets Firm/industry structure & Policy

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Transition of industry

Coevolution of: Technology Markets Firm/industry structure & Policy

Disaggregating structure

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Transition of industry

Coevolution of technology, markets, firm/industry structure, & policyDisaggregating structureWhere are the dynamic features?

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Monopoly defines technology

Efficiency assumptions unwarranted Historical examples Numbering systems AT&T’s integration strategy

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Disaggregating structure

Wholesale markets & their inhibitorsTraditional monopoly vision flawed

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Disaggregating structure

Wholesale markets…Traditional monopoly vision flawed Outdated view of end-to-end service

Not “natural & inevitable” product of technology

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Disaggregating structure

Thousands of functions to build & operate networks & provide different services Many improvements to economic

efficiency could arise from disaggregation

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Management’s question

Is there greater profit to be gained by cooperation with entrant or Is this policy change only a question of sharing “my” existing market with others?

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Management’s question

Is there greater profit …Is this policy change …? Where legacy scale & scope forces are

considerable, new entrants add little value by expanding markets but only compete for a market already served “efficiently” by the incumbent, given existing technological path.

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Potential investors’ questionWhat are the cost/risk associated with investment in entrants in this market?

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Potential investors’ questionWhat … cost/risk …? Is the regulator up to the task at hand?

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Policy makers’ question

What is required of us to make an open entry model feasible?

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Policy makers’ question

What is required …?

Wholesale access to resources of incumbents appeared obvious, but there was little understanding as to what specifically was going to be required to realize this change of policy or its consequences.

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Alternative models

If large, exogenous economies of scale & scope exist, then a policy that forces competition where it conflicts with technology imposes inefficiency, is wrongly conceived, and cannot be implemented without constant

intervention. Knight (1925) and Sraffa (1926) clearly analyze such

a situation.

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AlternativesWhere there are no significant scale and scope economies, monopolization of a sector is inefficient and the reluctant incumbent’s vertically integrated structure stands in the way of innovation and market growth. In the latter case, an incumbent’s integrated structure, focused on providing a limited set of end-user services, is an albatross for itself as well as for public welfare.

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Alternatives

Preserving its monopoly will limit the capital applied to the sector and thus also its market growth and opportunity.

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Alternatives

Preserving monopoly limits capital applied to the sector and thus also its market growth and opportunity. In a dynamic market setting the incumbent needs continually to examine its market opportunity and even rethink its structure.

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Alternatives

Most definitions of competition in telecommunications based on models that consider a single entrant that is essentially duplicating the incumbent.

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Alternatives Competition =(?) duplicating incumbent

Such a “monopoly-centric” approach is an easy path of analysis and is consistent with the hypothesis of a technology that is exogenous and known by all. It focuses on incremental changes to the

established environment and it uses the knowledge base associated with the status quo

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A French example

Regional independent construction companies utilized by France Telecom as well as its competitors build significant portion of local infrastructure. Those companies evidently have a comparative advantage in construction, facilities’ management and maintenance over the construction departments integrated into the legacy service companies.

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France

New entrants quickly discovered a wide range of rights-of-way and properties available that could be utilized more cheaply than the methods of incumbentsThat implies that there is the potential for a commercial market place for rights of way and construction that is broader than telecommunications and can be more efficiently pursued as an independent activity.

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In North America

Incumbents had long shared poles with public utilities. However, that appears to be more

of an administrative matter than an economic one.

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In North America

Incumbents shared polesBut, they never managed the communication space on poles as a commercial activity. They had to be mandated by federal legislation to share those facilities with the cable operators and, since 1996, with new entrants. This sharing has been far less common in other parts of the world.

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North America

The fact that many alternatives were cheaper helped new entrants but did not necessarily provide them with a competitive advantage

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North America

Alternatives cheaper but not competitive Entrants still had to link those other rights-of-way to achieve a complete network reaching desired nodes.

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North America

Alternatives cheaper but not competitive Entrants still need a complete network In the absence of well-developed specialized construction market, the linking of those piece parts was still costly.

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Scale & scope in dynamic markets

Scale & scope associated with: Technology Organization of technology Technology of the

organization

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Conclusion

“Returns to scale have their limits.” Tirole

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Conclusion

“…scale have …limits.” Tirole

Capacity bottlenecks plus agency problems can be contributors to the eventual emergence of diseconomies of scale in a firm.

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Conclusion“four major sources of economies of scale and scope: indivisibilities & the spreading

of fixed costs, increased productivity of

variable inputs (mainly having to do with specialization),

inventories, the cube-square rule” (Besanko et al. 2000 p.75)

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Conclusion

Limits to economies of scale & scope At any point in time or Over a finite time period

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Conclusion

Limits to scale & scope No justification for assertions re. economies of scale and scope of telecommunication serviced providers