1. de Fontenay & Liebenau Nov. 2005 1 Scale & Scope in the Telecommunications Industry: Implications for innovation & competition Alain Bourdeau de Fontenay Queen’s College, CUNY & Columbia University Jonathan Liebenau London School of Economics & Columbia University

2. de Fontenay & Liebenau Nov. 2005 2 Agenda Problem: Views of scale & scope & Policy effects Transition of industry Alternative models Framework Dynamic markets “Network of networks”

3. de Fontenay & Liebenau Nov. 2005 3 Problem Incumbents’ legacy structure Technology becomes entry barriers Unable to respond to market signals Unable to invest efficiently Unsustainable competitive advantage

4. de Fontenay & Liebenau Nov. 2005 4 Problem Distort markets due to: Sunk network plus Misguided assumptions New entrants Bankrupted, despite being More efficient

5. de Fontenay & Liebenau Nov. 2005 5 Problem No evidence incumbent more efficient Entrant difficulties falsely assumed to be: Inability to compete Scale & scope of incumbent

6. de Fontenay & Liebenau Nov. 2005 6 Tautology Technologies designed & adopted To the market structure Constitute conscious choices Not market efficiencies

7. de Fontenay & Liebenau Nov. 2005 7 Tautology Technologies designed & adopted Incumbent (monopoly) No need to respond to market forces Could adopt network designs & develop technology that furthered its mandate on other bases.

8. de Fontenay & Liebenau Nov. 2005 8 Legacy technology Observing legacy monopoly technology

9. de Fontenay & Liebenau Nov. 2005 9 Legacy technology Monopoly technology Not “efficient” in a economic or social welfare sense

10. de Fontenay & Liebenau Nov. 2005 10 Legacy technology Monopoly technology Not “efficient” Demonstration of scale & scope Not connected to efficiency Within the “sunk” network

11. de Fontenay & Liebenau Nov. 2005 11 Transition of industry Coevolution of: Technology Markets Firm/industry structure & Policy

12. de Fontenay & Liebenau Nov. 2005 12 Transition of industry Coevolution of: Technology Markets Firm/industry structure & Policy Disaggregating structure

13. de Fontenay & Liebenau Nov. 2005 13 Transition of industry Coevolution of technology, markets, firm/industry structure, & policy Disaggregating structure Where are the dynamic features?

14. de Fontenay & Liebenau Nov. 2005 14 Monopoly defines technology Efficiency assumptions unwarranted Historical examples Numbering systems AT&T’s integration strategy

15. de Fontenay & Liebenau Nov. 2005 15 Disaggregating structure Wholesale markets & their inhibitors Traditional monopoly vision flawed

16. de Fontenay & Liebenau Nov. 2005 16 Disaggregating structure Wholesale markets… Traditional monopoly vision flawed Outdated view of end-to-end service Not “natural & inevitable” product of technology

17. de Fontenay & Liebenau Nov. 2005 17 Disaggregating structure Thousands of functions to build & operate networks & provide different services Many improvements to economic efficiency could arise from disaggregation

18. de Fontenay & Liebenau Nov. 2005 18 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?

19. de Fontenay & Liebenau Nov. 2005 19 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.

20. de Fontenay & Liebenau Nov. 2005 20 Potential investors’ question What are the cost/risk associated with investment in entrants in this market?

21. de Fontenay & Liebenau Nov. 2005 21 Potential investors’ question What … cost/risk …? Is the regulator up to the task at hand?

22. de Fontenay & Liebenau Nov. 2005 22 Policy makers’ question What is required of us to make an open entry model feasible?

23. de Fontenay & Liebenau Nov. 2005 23 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.

24. de Fontenay & Liebenau Nov. 2005 24 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.

25. de Fontenay & Liebenau Nov. 2005 25 Alternatives Where 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.

26. de Fontenay & Liebenau Nov. 2005 26 Alternatives Preserving its monopoly will limit the capital applied to the sector and thus also its market growth and opportunity.

27. de Fontenay & Liebenau Nov. 2005 27 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.

28. de Fontenay & Liebenau Nov. 2005 28 Alternatives Most definitions of competition in telecommunications based on models that consider a single entrant that is essentially duplicating the incumbent.

29. de Fontenay & Liebenau Nov. 2005 29 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

30. de Fontenay & Liebenau Nov. 2005 30 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.

31. de Fontenay & Liebenau Nov. 2005 31 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 incumbents That 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.

32. de Fontenay & Liebenau Nov. 2005 32 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.

33. de Fontenay & Liebenau Nov. 2005 33 In North America Incumbents shared poles But, 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.

34. de Fontenay & Liebenau Nov. 2005 34 North America The fact that many alternatives were cheaper helped new entrants but did not necessarily provide them with a competitive advantage

35. de Fontenay & Liebenau Nov. 2005 35 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.

36. de Fontenay & Liebenau Nov. 2005 36 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.

37. de Fontenay & Liebenau Nov. 2005 37 Scale & scope in dynamic markets Scale & scope associated with: Technology Organization of technology Technology of the organization

38. de Fontenay & Liebenau Nov. 2005 38 Conclusion “Returns to scale have their limits.” Tirole

39. de Fontenay & Liebenau Nov. 2005 39 Conclusion “…scale have …limits.” Tirole Capacity bottlenecks plus agency problems can be contributors to the eventual emergence of diseconomies of scale in a firm.

40. de Fontenay & Liebenau Nov. 2005 40 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)

41. de Fontenay & Liebenau Nov. 2005 41 Conclusion Limits to economies of scale & scope At any point in time or Over a finite time period

42. de Fontenay & Liebenau Nov. 2005 42 Conclusion Limits to scale & scope No justification for assertions re. economies of scale and scope of telecommunication serviced providers