Economic characteristics and policy challenges of NGANs Glenn A Woroch C.R.T.P. / UC Berkeley Policy for Next Generation Networks: European and US Perspectives MIT Communications Futures Program 27 March 2009 Overview 1. 2. 3. 4. 5. 6. Engineering & economic properties of NGANs Competition & regulatory concerns Policy options & economic criteria Vertical separation as a remedy Different approaches in the U.S. and E.U. Open questions & policy challenges 1. What is the NGAN? Consensus so far … Converged: IP transport of all kinds of content to all kinds of devices Layered: OSI and other layered architectures Modular and Open: interoperability among layers, components Backward compatible: interoperate with legacy PSTN and data networks What is the NGAN? Not your father’s Internet Consolidation of ATM, SONET, Ethernet, MPLS More than best effort: carrier class, security But still a work in progress Competing technologies: FTTx’s, xDSL’s, etc. Competing architectures: star, PON, etc. Open and proprietary technologies Distinct economic features of NGAN Natural monopoly at the core Open entry at the edges High fiber results in high fixed costs, low marginal costs Impediments to facility sharing Open interfaces, standard protocols Limited capacity of critical facilities Converged devices at the ends Need to manage connections & traffic 2. Competitive & regulatory concerns How to respond to a fortified access monopoly? How to maintain progress toward competition in retail services? How to preserve incentives to invest in facilities and to rollout innovative services? How to transition from current institutions? Competitive concerns Disadvantage downstream rivals Margin squeeze Quality sabotage Refusals to supply Tying and bundling Technical incompatibilities Vertically integrated bottleneck monopoly V.I.M. Retail rival Consumers Regulatory concerns What parts of NGAN are natural monopolies? Distinguishing new from legacy bottleneck facilities How carve out potentially-competitive portions of the NGAN? Engineering: layers Economics: markets Regulatory concerns (cont’d) What policy to impose on the boundaries of the NGAN? Nondiscriminatory access Full interoperability How to transition from legacy network and ownership structure to NGAN? Maintain regulation on legacy network? “Regulatory holiday” for NGAN? 3. Policy options & economic criteria Objectives of policy intervention Economic criteria for evaluating policies Structural and behavioral strategies What are the objectives of intervention? Curb monopoly excesses Prevent exclusionary behavior Promote efficient entry and competition Facilitate investment in infrastructure Preserve incentives to innovate Economic guidelines for policy analysis Overarching criterion should be efficiency Time is of the essence Consumer welfare is paramount But measured by social welfare Not just short term or just long term Dynamic progress critical to network evolution Policies need to be “incentive compatible” All agents will pursue their private interests Policy options Forbearance Promotion of platform competition Opening access network and unbundling Facility sharing Vertical separation Ex ante regulation Ex post competition policy 4. Vertical separation as remedy Kinds of vertical separation Vertical separations experiments in U.S., E.U., and elsewhere Economic benefits and costs of separation Obstacles to separation Why the interest in separation now? Dissatisfaction with progress toward competition Lack of entry under unbundling policies Slow development of platform competition Fear that NGAN could reverse progress Opportunity to establish dominance in new infrastructure market Such dominance could be extended to retail Vertical separation Access Division Retail Division Retail rival Consumers Degrees of vertical separation/integration Full integration Quasi-integration Long term contracting Nonstructural separation Forward and backward integration Accounting separation Functional separation Operational separation Structural (ownership) separation Reciprocal partitioning Club ownership No vertical integration Four degrees of separation Accounting Operational Functional Structural Telecom separation around the world Efficiencies of vertical separation Benefits Eliminates of cross subsidies Eliminates conflict of interest Counteracts discriminatory treatment of retail rivals Costs Forgoes vertical scope economies Causes double marginalization Lowers reliability due to quality externality Raises transaction costs Blunts incentive for access investment Obstacles to vertical separation Divorced facilities may not be sharable Certain portions of a non-IP video market Separation may preclude certain bundled services Access + retail services, especially for businesses Arms’ length contracting alternative can be costly 5. Divergence in U.S. and E.U. approaches Origins of institutions and property rights of the two telecoms sector were vastly different Current network infrastructure and industry structure varies considerably in EU, but not in the US Subtle but fundamental differences in competition policy Example of competition policy differences U.S. E.U. Quality degradation Trinko (2005) IMS Health (2004) Microsoft (2004) Price/margin squeeze LinkLine (2008) Deutsche Telekom (2003) Telefonica (2007) Separation policy in the U.S. Anti-trust separations LOB restrictions on AT&T in 1956 Divestiture of AT&T in 1984 Regulatory separations FCC’s Computer I, II, III LOB restrictions on RBOCs PSCNY’s Rochester Tel experiment in 1995 SBC’s separation of DSL service in 2001 Failure of state nonstructural separations (e.g., Pennsylvania) Separation policy in Europe Regulatory stance on separation in the EC OECD separation recommendation (2001) EC recommendations on accounting separation (1998, 2004) Reding speech (2006) OFCOM-BT’s undertakings in 2005 Separation of OpenReach and BT Retail Applies to 21CN products But much earlier there was the French approach to vertical separation … 6. Open questions & policy challenges Implementing vertical separations Enforcing non-discrimination Measuring success Implementing vertical separation Pre-conditions for separation policy Activity prone to “enduring bottleneck” Complements are potentially competitive Bottleneck monopolist integrated into the complementary markets Essential elements of vertical separation Quarantine of bottleneck Isolate of essential facilities Impose line-of-business restrictions Regulate the bottleneck Dictate range of wholesale access services Enforce price and quality nondiscrimination Measuring success Direct measures of success Entry of new firms upstream and downstream Facilities based or service based Development of infrastructure/platform competitors (e.g., wireless) Indirect measures of success Lower retail prices, higher service quality Expanded retail service offerings Measuring success (cont’d) All impacts need to be evaluated incremental to the status quo Any unbundling regime Any access/interconnection pricing regulation Any form of vertical separation Case of Italy Unbundling Interconnection pricing Operational separation of network services Various non-discrimination principles OFCOM’s “equivalence of inputs” Same products, sold at same prices, using same order processes as BT’s retail division Applied to certain existing and future products FCC’s “parity principle” TCNZ’s “fair and equivalent” AGCOM’s “parity of internal-external treatment” (152/02/CONS) Competitors can replicate TI’s retail services Why non-discrimination may not be good Retailers value input quality differently Some retailers prefer lower quality input if they receive a sufficient price break Sabotage may impose cost on access supplier Greater costs to creating multiple qualities of an input Greater sales to the advantaged affiliate retailer offset by reduced sales to rival retailer Performance measurement: the plan Map indicators of wholesale service into monetary penalties Benchmark is service received by bottleneck’s retail division Induce bottleneck monopoly to provide equivalent service to retail rivals Discriminatory treatment becomes sufficiently costly Performance measurement: the reality Evolution of PMPs Measures divide and multiply Penalties occur for uncontolled events Competitors learn to “game the system” Link between effort and penalty becomes weak PMP distorts behavior of incumbent and its competitors