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Introduction The Model Equilibrium access charges Commitment contracts Discussion
Investment with commitment contracts:The role of uncertainty
EuroCPR 2010
Claudia Saavedra [email protected]
Ecole Polytechnique
30 March 2010
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Motivation
Telecom infrastructure an heritage of the formerly State-ownedmonopolyUpgrade and renovation of infrastructureRegulatory authorities will likely apply ex ante regulation forwhoever builds a networkFostering retail market competition without hindering investmentcan be a challenging objective
Introduction The Model Equilibrium access charges Commitment contracts Discussion
The aport of this paper
What is the paper’s main question?
Private incentives to invest on a new network when it cannot befinanced by direct subsidies and revenues from the market are theonly source of fundingApplication to game theory to investment incentivesIndustry players are uncertain about future industry profitability
Introduction The Model Equilibrium access charges Commitment contracts Discussion
The aport of this paper
Overview of the results
Access regulation gives firms a second-mover advantageFor adverse market configurations, more sophisticated accesscontracts including commitment clauses between firms can bemore efficient than simple linear wholesale access tariffs.
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Framework
The Model
Two ex ante identical firms in an infrastructure-based industrySunken cost for building the facility I > 0
FBC Facilities-based competitionTwo firms with infrastructure
SBC Service-based competitionOne firm with infrastructure
NC No service is providedFuture industry profit flows are uncertain
Good state (high profits) θH with probability µ ∈ [0, 1]Bad state (low profits) θL with probability 1− µ0 < θL < θH
θ is revealed only if investments are made
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Framework
The Model
Two ex ante identical firms in an infrastructure-based industrySunken cost for building the facility I > 0
FBC Facilities-based competitionTwo firms with infrastructure
SBC Service-based competitionOne firm with infrastructure
NC No service is providedFuture industry profit flows are uncertain
Good state (high profits) θH with probability µ ∈ [0, 1]Bad state (low profits) θL with probability 1− µ0 < θL < θH
θ is revealed only if investments are made
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Framework
Cournot competition p = 1− (q1 + q2)Facilities-based competition profits
ΠC = θ {qi(p− c)}︸ ︷︷ ︸profit flow
−I
c ∈ [0, 1] marginal infrastructure usage cost,Service-based competition profits for the access Provider and the
access Seeker
ΠP (w, θ) = θ {q1(p− c) + q2(w − c)} − IΠS(w, θ) = θ {q2(p− w)}
c < w < 1 usage-based access chargeNo infrastructure Π = 0
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Framework
Cournot competition p = 1− (q1 + q2)Facilities-based competition profits
ΠC = θ {qi(p− c)}︸ ︷︷ ︸profit flow
−I
c ∈ [0, 1] marginal infrastructure usage cost,Service-based competition profits for the access Provider and the
access Seeker
ΠP (w, θ) = θ {q1(p− c) + q2(w − c)} − IΠS(w, θ) = θ {q2(p− w)}
c < w < 1 usage-based access chargeNo infrastructure Π = 0
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Framework
Cournot competition p = 1− (q1 + q2)Facilities-based competition profits
ΠC = θ {qi(p− c)}︸ ︷︷ ︸profit flow
−I
c ∈ [0, 1] marginal infrastructure usage cost,Service-based competition profits for the access Provider and the
access Seeker
ΠP (w, θ) = θ {q1(p− c) + q2(w − c)} − IΠS(w, θ) = θ {q2(p− w)}
c < w < 1 usage-based access chargeNo infrastructure Π = 0
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Framework
Timing of the game1 Nature chooses θH or θL
2 Regulatory authority sets the access charge w3 Firms simultaneously decide invest or to delay investment→ If at least one firm invests θ is revealed. Then the other firm chooses to
seek access or stay out of the market or to bypass and build own
infrastructure
4 If investment, retail competition
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Retail market equilibrium
Retail equilibrium
There exists a retail market equilibrium such that profit flows:
πs(w)︸ ︷︷ ︸access seeker
< πc︸︷︷︸facilities competition
< πp(w)︸ ︷︷ ︸access provider
< πm︸︷︷︸monopolist
whenever c < w < wm.wm: access charge foreclosing the access seeker
Industry profits:
ΠC(θ) = θπc − IΠP (w, θ) = θπp(w)− IΠS(w, θ) = θπs(w)
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Retail market equilibrium
Retail equilibrium
There exists a retail market equilibrium such that profit flows:
πs(w)︸ ︷︷ ︸access seeker
< πc︸︷︷︸facilities competition
< πp(w)︸ ︷︷ ︸access provider
< πm︸︷︷︸monopolist
whenever c < w < wm.wm: access charge foreclosing the access seeker
Industry profits:
ΠC(θ) = θπc − IΠP (w, θ) = θπp(w)− IΠS(w, θ) = θπs(w)
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Retail market equilibrium
Additional assumption
Facilities based competition is viable only in a good state
ΠC(θH) ≥ 0 ≥ ΠC(θL)
0
ΠC(θH)
w access charges
Profits
ΠC(θL)
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Retail market equilibrium
Additional assumption
Facilities based competition is viable only in a good state
ΠC(θH) ≥ 0 ≥ ΠC(θL)
0
ΠC(θH)
w access charges
Profits
ΠC(θL)
ΠS(w, θL)
ΠS(w, θH)
ΠC(θL)
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Retail market equilibrium
Additional assumption
Facilities based competition is viable only in a good state
ΠC(θH) ≥ 0 ≥ ΠC(θL)
0
ΠC(θH)
w access charges
Profits
ΠS(w, θH)
w̃
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Benchmark: Perfect Information
Invest Seek accessInvest ΠC(θ) , ΠC(θ) ΠP (w, θ) , ΠS(w, θ)
Seek access ΠS(w, θ) , ΠP (w, θ) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)
Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)
Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)
Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)
Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Invest Seek accessInvest ΠC(θH) , ΠC(θH) ΠP (w, θH) , ΠS(w, θH)
Seek access ΠS(w, θH) , ΠP (w, θH) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Perfect Information
Invest Seek accessInvest ΠC(θH) , ΠC(θH) ΠP (w, θH) , ΠS(w, θH)
Seek access ΠS(w, θH) , ΠP (w, θH) 0 , 0
Investment equilibrium
θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium
θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Uncertainty
Uncertain θ
With analogous (but slightly more complicated) analysis:
First important result
If the firms have the option to wait for the other firm to invest andreveal θ then (Invest today, Invest today) is not equilibrium for anyaccess charge.
Then the regulatory authority needs encourage(Invest today, Seek access) or (Invest today, Invest tomorrow)equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Uncertainty
Uncertain θ
With analogous (but slightly more complicated) analysis:
First important result
If the firms have the option to wait for the other firm to invest andreveal θ then (Invest today, Invest today) is not equilibrium for anyaccess charge.
Then the regulatory authority needs encourage(Invest today, Seek access) or (Invest today, Invest tomorrow)equilibrium
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC
Equilibrium access charges
Service-based competition equilibrium
There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.
c
wm
w̃
I Investment cost
access charges
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC
Equilibrium access charges
Service-based competition equilibrium
There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.
c
wm
w̃
I Investment cost
access charges
Service-based competition
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC
Equilibrium access charges
Service-based competition equilibrium
There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.
c
wm
w̃
I Investment cost
access charges
Facilities-based competition
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC
Equilibrium access charges
Service-based competition equilibrium
There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.
c
wm
w̃
I Investment cost
access charges
wSBC
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC or FBC
x-based competition equilibrium
There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL
induces facilities-based competition if θH
c
wm
w̃
I Investment cost
access charges
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC or FBC
x-based competition equilibrium
There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL
induces facilities-based competition if θH
c
wm
w̃
I Investment cost
access charges
wxBC
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC or FBC
x-based competition equilibrium
There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL
induces facilities-based competition if θH
c
wm
w̃
I Investment cost
access charges
wSBC
wxBC
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC or FBC
x-based competition equilibrium
There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL
induces facilities-based competition if θH
c
wm
w̃
I Investment cost
access charges
wSBC
wxBC
Risk premium
@@R
Introduction The Model Equilibrium access charges Commitment contracts Discussion
SBC or FBC
x-based competition equilibrium
There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL
induces facilities-based competition if θH
c
wm
w̃
I Investment cost
access charges
no investment
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Alternative contracts
Negotiated access contracts
To induce investmentAccess contracts with commitment clauses between firms are oneanswer to the dilemma of preserving market competition andencouraging investment in adverse market configurations.
c
wm
w̃
I Investment cost
access charges
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Alternative contracts
To improve static efficiency
If the only possible investment equilibrium is xBC, and if it requires ahigh wholesale price, then commitment clauses allow to lower accesscharges improving static efficiency.In particular, there exists a range of wholesale prices that areincentive compatible for both firms.
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Final comments
Discussion
Simple game examines investment incentives when firms aresubject to access regulationAccess regulation gives firms a second-mover advantageIn order to induce investments, the regulatory authority has twooptions:
Set low access charge that discourages opportunistic bypassingSet high access charge that compensates the leading investingfirm for loss revenues in good states
In adverse market configurations, access contracts withcommitment clauses encourage investments with lower accesscharges improving static efficiency
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Final comments
Discussion
Simple game examines investment incentives when firms aresubject to access regulationAccess regulation gives firms a second-mover advantageIn order to induce investments, the regulatory authority has twooptions:
Set low access charge that discourages opportunistic bypassingSet high access charge that compensates the leading investingfirm for loss revenues in good states
In adverse market configurations, access contracts withcommitment clauses encourage investments with lower accesscharges improving static efficiency
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Final comments
Discussion
Simple game examines investment incentives when firms aresubject to access regulationAccess regulation gives firms a second-mover advantageIn order to induce investments, the regulatory authority has twooptions:
Set low access charge that discourages opportunistic bypassingSet high access charge that compensates the leading investingfirm for loss revenues in good states
In adverse market configurations, access contracts withcommitment clauses encourage investments with lower accesscharges improving static efficiency
Introduction The Model Equilibrium access charges Commitment contracts Discussion
Final comments
Thank your for your attention