Unbundling the incumbent: Evidence from UK broadband

1. Unbundling the incumbent: Evidence from UK broadband M. Nardotto (ParisTech), T. Valletti (Imperial and ParisTech) and F. Verboven (KU Leuven)

2. Introduction • Policies aimed at “opening” the incumbent have been often applied: • Electricity market • Transportation • OUR CASE: Telecommunications (all over EU, and elsewhere – not US though) • Motivation: higher competition downstream should lead to lower prices, higher quality and more demand • Fewempiricalstudiesanswering the question: DOES IT WORK?

3. Thispaper • We study the broadband market in UK, where: • BT owns the network (Local Exchanges) • Twopossible entry strategies (downstream): • Bitstream: low investment, BT still provides most of the service (reduced area of responsibility of entrant) • Local-Loop Unbundling (LLU): bigger investment by entrants. • Another competitor is cable (NTL:Telewest, now Virgin) with a competing “closed” network

4. Thispaper – findings • MAIN QUESTION: Did entry through LLU induce market expansion? • RESULT: penetrationisnotimprovedby LLU • Then, we show: • Incentives for LLU change the composition of entrants’ technological portfolio • Inter-Platform competition leads to more penetration (BT lines v.s. cable)

5. Relatedliterature • Theory papers (surveys of Armstrong, Laffont and Tirole) • Very rich policy (and advocacy) debate. Very few empirical works, almost no micro-data. • Grajek and Roller (2011, JLawEc): Regulation negatively affects total investments in facilities. Panel of EU countries, aggregate data. • Sraer (2008): WP on LLU and penetration (French data), Fevrier, Gaubert and Sraer(2011): structural model (cross-section) • Minamihashi (2011): effect of regulation of both LLU and fiber in Japan. Regulation made more difficult to invest in fibre. • Studies on entry in US using earlier data: Greenstein and Mazzeo (2006, JIndEc), Economides, Seim and Viard (2008, RAND), Xiao and Orazem (2011, IJIO), Goldfarb and Xiao (forthcoming, AER)

6. Broadband market • Broadband in UK isprovidedby: • Fixedlinetelephoneoperators • Cableoperator • British Telecom group (BT retail/BT wholesale/ Openreach) is the incumbent of the fixed line telephone network • Virgin Media is the only cable operator (network built in the 80’s) • BT’s network has a (fiber) backbone and serve consumerslocallythrough delivery points (localexchanges, LEs) which cover the “last mile”

7. Broadband market • Each household is connected to a specific LE in the grid

8. Broadband market • Late 90’s: BT opened the “last mile” to entrants • RegulationbyOfcom: • BT had to upgrade the network to allow for entry (completed in 2002-03) • Regulated wholesale prices that entrants have to pay to BT • Entry options: • (Simple re-selling) • Bitstream: low investmentby the entrant in the LE, the connection isstillmanagedby BT • LLU: higher investment by the entrant. Entrants install DSLAM equipment, routers, cabinets, provide maintainance, etc

9. Local Exchanges (LEs) Called “Central Offices” in the US 5,587 LEs in the UK grid Becoming LLU supplier costs approx £100k per LE (one-off), plus ongoing costs

10. Regulation and goals • Regulator’s perspective (Ofcom WBA rev. 2006):“The importance of broadband continues to grow. It plays a central role in communications used by many consumers and businesses to keep in touch, access information and conduct business.”“Competition has an important role to play in delivering what consumers and businessesneed”“Competition at the retail level depends on ISPs having access to wholesale broadband services or local loop unbundling (LLU) to build their services. Ofcom has identified that competition between networks based on LLU, rather than just at the retail level based on wholesale broadband products, is crucial to maintaining the UK's broadband progress.”

11. Data • Quarterly panel data on investments and subscriptions in the period 2005 (Dec) – 2010 (Jan) at the LE level (5,587). In each LE weobserve: • Postcode and geographical coordinates • Total number of potential lines (households) • Numberoflinespotentiallyservedbycable • Lines actually served by cable • Linesservedbyentrantsthrough LLU (disaggregatedbyoperator) • Total linesservedbybit-stream • Total lines with broadband (LLU + cable + bit-stream)

12. Penetrationovertime • Penetrationincreasessignificantlyoverourtimespan

13. Relative sharesof the technologies • Over time therelative shareof BT retail is stable • Entrants substitute bit-stream withLLU

14. LLU expansion • In fewyears the adoptionof LLU becomes more widespread:

15. Whole BT grid of LEs + cable

16. LLU and Entry - 1 • The 677 LEswhereweobserve LLU are different:

17. LLU and Entry – 2 • And the difference is still there in period 17 (entry tripled to 1,985 LEs)

18. LLU and Entry - 3 • Entrantsmake LLU investmentwhere the market isprofitable, i.e. • Itislarger in size • Incomeishigher • Maintainance can bedone more efficiently • Hence, itiscrucial for identification, tocontrol for unobservedheterogeneity in the local LE markets

19. LLU and Entry - 4 • We estimate the followingmodel: • Where the regressors are: • Sizeof the LE (numberoflines) • Dummy variable for urbanareas

20. LLU and Entry - 5 ProbitregressionNumberofobs = 5517 LR chi2(2) = 1436.60 Prob > chi2 = 0.0000 Log likelihood = -1335.6417 Pseudo R2 = 0.3497 ------------------------------------------------------------------------------ LLU cov. | dy/dxStd. Err. z P>|z| [ 95% C.I. ] X ---------+-------------------------------------------------------------------- Size | .0110998 .00066 16.84 0.000 .009808 .012392 4.97406 Urban | .0762649 .01026 7.43 0.000 .056147 .096383 .349828 ------------------------------------------------------------------------------ • The average size in the sample is 5,000 lines. At thissizeveryfew are activated. • The difference in the activationprob. between a 5,000 lines LE and a 15,000 lines LE is 11% • The difference in the activationprob. between a LE in a urban area and LE in a non urban area is 7.6%

21. Does LLU increasepenetration? • We estimate a panel regression for the penetration: • We use the F.E. estimator • Two LLU entrants particularly important in the data, Sky (TV) and CPW (who in the period bought AOL, Tiscali, Talk Talk) • Account also for some spatial (neighbourhood) effect • Additional regressor is the time since LLU is activated

22. Panel FE estimation

23. LLU vs. Bit-Stream • Do firmchangetheirtechnology?

24. LLU vs. Bit-Stream

25. Possibleexplanations • Firmsmaynotengage in price competition. • Howto test it? Bresnahan – Reissapproach: look at the market sizeneededtosustainanextra-entrant: • Ifthereiscompetitionthen ETR shouldbegreaterthan 1 and increasing

26. Possibleexplanations • Estimatedthesholds:

27. Possibleexplanations • Lack of competition • Product differentiation? • Heterogenous entrants? • “Ladder of investment” does not seem to work • Locus of competition is not price, rather quality

28. Next steps/Ongoing work • We are collectingdemographics at the LE level (complicatedbutfeasible) • Penetrationmaynotbe the onlyobjective, in particularwe are collectingdata on: • Speedof the connection • Reliabilityof the service • We are also looking at the entry strategies (product differentiation) • Also, recomputing entry plus exit threshold ratios with simple entry dynamic model